Fannie, Freddie stock, bond investors face off

NEW YORK (Reuters) - Bond holders and stock holders of Fannie Mae and Freddie Mac are rooting for different teams.

Fixed-income investors want the two U.S. home finance companies to issue shares to shore up capital. But for equity investors, diluting their investment is the last thing they desire, given the spectacular drops in the shares in the last year.

The companies, which have been given a central role by Congress in restoring the U.S. housing market to health, may have to seek more capital under tougher conditions in coming months, escalating the strife between shareholders and bondholders.

Investors have watched Fannie and Freddie shares plummet more than 60 percent this year after soaring delinquencies on home loans resulted in billions of dollars of losses.

The predicament for Fannie Mae and Freddie Mac has produced a chasm between shareholders and bond holders, including those in the mammoth $4.5 trillion "agency" mortgage bond market. Money managers are not turning their backs on Fannie Mae and Freddie Mac fixed-income securities -- as many have with their shares -- on belief their money is safe.

Further deterioration in housing will harshly test the balance sheets of the companies, leaving them little choice but to ask for money from the very investors who made losing bets on previous capital-raisings.

"Their profitability is not assured," said Andrew Harding, chief investment officer of fixed-income at Allegiant Asset Management, noting that is the reason their shares are "really challenged."

It's a different story for Fannie's and Freddie's fixed-income securities. Their agency debt and mortgage-backed securities they guarantee are "protected in the sense that they are going to pay their bills," Harding added.

Long-held views that the companies, chartered by Congress, have the implicit backing of the government has steeled the nerves of bond investors as well.

STOCK HEADED FOR SINGLE DIGITS?

"There is a big mortgage problem out there. Fannie and Freddie are the biggest in mortgages. Fannie and Freddie have a big problem," said Jeffrey Gundlach, chief investment officer at Los Angeles-based bond manager Trust Company of the West.

He added: "It's like everything else, there's too much leverage in the system. In this case, it's not hedge-fund type of leverage. With Fannie and Freddie, there are too many guarantees against the capital base -- end of story."

In that regard, Gundlach sees the companies tapping the markets again for capital to boost their balance sheets.

"That is a disaster for the existing shareholders," he said. "The stock is probably going effectively to the single digits."

Fannie shares were trading at $16.58 on Wednesday, down from around $70 last August. Freddie shares were trading at $11.84, down from around $66 in August.

Bond investors will do "very well" if an infusion of capital occurs, Gundlach said. That is because Fannie and Freddie are "going to still be around to guarantee," he added.

Lawmakers and regulators want to make sure that happens, and investors know it.

Fannie Mae and Freddie Mac are being encouraged by lawmakers and regulators to grab market share, since many Wall Street programs that fueled the housing bubble have been frozen for nearly a year. Even the Bush administration, which spent most of the past seven years trying to shrink the companies, has been underscoring their importance to the economy.

But fuel for that growth has to come from somewhere, and revenues, while strengthened, are no where near enough to offset the losses from housing, analysts say. This means capital is needed, on top of some $20 billion already raised by the companies since last fall.

WINDOW CLOSING

Even if the companies decide to issue more stock, investors are beginning to doubt the capital-raising ability of the companies, which have had to turn willing investors away from earlier offerings.

Selling common stock prices at depressed prices would sharply dilute the value of existing shares. Buyers of preferred shares from past capital increases are staring at losses, making them less willing supporters.

"I don't think I can make a huge bet here," said Ed Walczak, a portfolio manager at New York-based Vontobel Asset Management Inc. Fannie and Freddie shares each make up 1 percent of Vontobel's holdings, down from 3.5 percent of each within the last year.

David Dreman, chairman of Jersey City, New Jersey-based Dreman Value Management, LLC, one of the largest holders of Fannie Mae and Freddie Mac, added: "A lot of people have lost money on all these (capital) underwritings and obviously they are more sensitive. It's going to be harder to raise capital."

Lehman Brothers on Monday fanned capital worries, noting that a pending accounting change could force the companies to raise as much as $75 billion in new capital. The companies may get an exception, Lehman said, but just the mention of the possibility shattered a market already on tenterhooks.

(Reporting by Jennifer Ablan and Al Yoon in New York; Editing by Dan Grebler)