Fannie, Freddie shares sink again on capital worries

NEW YORK (Reuters) - Fannie Mae (FNM.N) and Freddie Mac (FRE.N) shares took a fresh beating on Wednesday on renewed worry that the two home finance companies may need to raise massive amounts of new capital through stock sales and devalue existing shareholders' stakes.

Wednesday's drop marked the second double-digit percentage fall in three days for both stocks and comes as U.S. officials increasingly lean on them to provide funding to help pull the U.S. housing market from its worst slump since the Great Depression.

Earlier this week, concern that a proposed accounting rule would require the companies to raise billions in capital added to investors' jitters over whether the government-sponsored enterprises can withstand more losses and support housing.

After a respite on Tuesday, the shares resumed their fall. Freddie Mac shares slid 23.8 percent to $10.26, after briefly breaking into single digit territory, while Fannie Mae shares fell 13.11 percent to $15.31.

"They're going to have to raise capital going forward. It's going to be diluted transaction (and) there's nothing we can do about it," said Weston Boone, a vice president of listed trading at Stifel Nicolaus Capital Markets in Baltimore. "Fannie and Freddie will continue to lend, continue to be the majority of the mortgages in this country."

Freddie Mac shares took the biggest hit in part because the company said this spring that it would raise $5.5 billion in new capital through the sale of stock. Given the recent sharp share drops, it window of opportunity to sell new equity has likely closed.

Freddie Mac spokeswoman Sharon McHale did not immediately return a call seeking comment on the share drop, investor perception or capital concern. In an e-mail, she declined to elaborate on the timing of Freddie's promised capital raise.

Credit default swaps for Fannie Mae and Freddie Mac also widened on Wednesday as the cost of insuring their debt for five years via swaps rose to about 80 basis points, or $80,000 a year to protect $10 million of debt, up from about 75 basis points a day earlier, according to a trader.

Risk premiums on most Fannie Mae and Freddie Mac agency debentures, issued to finance their mortgage purchases, increased on Wednesday.

At the same time, Fannie Mae sold $3 billion of new 2-year notes on Wednesday at a 0.74 percentage point yield premium to Treasuries, a record for this maturity.

Accounting rule makers are considering a move that could force companies to account for securitized assets, such as mortgage-backed securities, on their balance sheets. A strict reading of that rule would force Fannie Mae and Freddie Mac to raise billions of dollars of added capital to support trillions in MBS, according to a Lehman Brothers report on Monday.

The regulator for Fannie Mae and Freddie Mac eased some concerns on Tuesday, saying any accounting rule change will not require a massive capital increase by the two companies.

But several analysts and the former head of the government sponsored entities' regulator, the Office of Federal Housing Enterprise Oversight, said it will be difficult for Fannie and Freddie to sidestep the proposed accounting rules.

"OFHEO does not have the flexibility to ignore generally accepted accounting principles," Armando Falcon, who headed the Office of Federal Housing Enterprise Oversight through May 2005, told Reuters in an interview.

"The market is dominated by sharks who at this point smell blood and are shorting this stock" after Falcon's comments, said Marshall Front of Front Barnett Associates in Chicago, which holds Fannie Mae shares. "There is intensive short activity and tremendous volatility."

Front contends it is extremely unlikely that the "government would allow a change in accounting rules to have the kind of adverse impact" on Fannie Mae and Freddie Mac at a time when the government is calling on the two companies to help stabilize one of the worst housing markets in decades.

Their regulator this year relaxed surplus capital requirements for Fannie and Freddie that were put in place after accounting scandals earlier this decade.

"To loosen their capital requirements and then force them to raise $75 billion in new capital is a bit disingenuous," said Malcolm Polley, chief investment officer at Stewart Capital Advisors in Indiana, Pennsylvania.

Jeffrey Gundlach, chief investment officer at Los Angeles-based bond manager Trust Company of the West, said the growing awareness of the implications of large capital raises is hammering away at the companies' shares.

"It is very very negative for existing shareholders. Fannie and Freddie need capital and that source of capital may end up being the U.S. government," he said.

(Additional reporting by Kristina Cooke, Deborah Jian Lee, Al Yoon and Jennifer Ablan; Editing by Dan Grebler)