May 5, 2008 / 12:01 PM / 9 years ago

More big losses expected from Fannie, Freddie

<p>The headquarters of mortgage lender Fannie Mae is shown in northwest Washington October 3, 2006. REUTERS/Jason Reed</p>

NEW YORK (Reuters) - Fannie Mae and Freddie Mac will likely post steep first-quarter losses due to the U.S. housing market slump, although the two largest home-funding companies will likely avoid a repeat of record losses.

Sliding house prices and rising foreclosures among even the high-quality loans that comprise the bulk of business at the two federally chartered companies have eroded their income.

While the losses were likely tempered after the two raised their fees and as the credit crunch drove many of their rivals to the sidelines, they are still expected to need to raise significant additional capital.

“It’s probably the most challenging environment that they’ve seen in their histories,” said Moshe Orenbuch, equity research managing director at Credit Suisse in New York, who assigns an “underperform” rating to both companies.

The Standard & Poor‘s/Case-Shiller home price index of 20 metro areas fell 2.6 percent in February, for an annual drop of 12.7 percent. Foreclosure filings surged 23 percent in the first quarter, and were more than double a year earlier, according to RealtyTrac.

Rising delinquencies and foreclosures have forced both companies to write down the value of mortgage assets they own and boost reserves to cover payment guarantees on bonds held by investors.

Fannie Mae, whose shares have tumbled more than 50 percent over the last 12 months, will be first out of the chute when it reports first-quarter results on Tuesday. Freddie Mac, whose shares have fallen nearly 60 percent over the same period, is scheduled to post its results on May 14.

Wall Street analysts see Fannie Mae reporting a $2.02 billion loss, $1.48 per share, according to Reuters Estimates.

The projected loss would be a deterioration from net earnings of $826 million, or 85 cents per share, a year earlier, it would be an improvement from the previous quarter. In the fourth quarter, the largest source of U.S. home funding had a record $3.6 billion loss largely due to derivative contracts used to hedge its investment portfolio.

Both companies are expected to report large first-quarter derivatives losses due to the difficulty they likely had in estimating their interest-rate exposure at a time when the credit crunch whipsawed bond markets, analysts say.

Freddie Mac is expected to report a $920.6 million first-quarter loss, or $1.22 per share, according to Reuters Estimates. In the year-ago quarter, it lost $211 million, followed by a record $2.5 billion loss in the final quarter of 2007.

The two companies have been raising fees to better reflect the rising risk in home lending.

“We know you are hurting, but so are we. That’s why we’re tightening our credit box, using risk-based pricing, etc,” Patti Cook, Freddie Mac’s chief business officer, said in prepared remarks for a mortgage bankers event in Boston on Monday.

“Freddie Mac is well positioned to meet the challenges of the unsettled market.”

PROFITS AHEAD?

The profit outlook will be helped by an agreement with their regulator, the Office of Federal Housing Enterprise Oversight, that loosened restrictions on how much capital the two lenders must hold. That freed Fannie FNM.N and Freddie FRE.N to buy up to an additional $200 billion of mortgages.

As part of the deal with their regulator, the companies also pledged to raise fresh capital. Analysts say it would be best for each to raise at least $10 billion of preferred shares or common stock, but they expect far smaller amounts initially.

Once the latest quarterly results are published, the companies can begin to raise capital, said Rajiv Setia, director of U.S. fixed-income strategy at Barclays Capital. “There’s clearly tremendous appetite for preferred shares, so I don’t think raising capital is going to be an issue at all.”

The challenge is doing it without diluting existing shares or hurting the companies’ credit quality.

“The question really is that if they do more preferred, can they get away with it from a rating agency perspective and not get downgraded on the existing preferred?” Setia said.

Fannie Mae and Freddie Mac have also taken a series of steps, including raising fees they charge for their guarantees on mortgage bonds, to bolster profits.

“From a longer-term perspective, the fundamentals of the business are improving, both on the guarantee side where they are raising fees, as well as on the portfolio side where growth has resumed, and they are adding mortgage assets at very attractive spreads,” said Setia.

Additional reporting by Al Yoon in Boston; Editing by Tom Hals

Our Standards:The Thomson Reuters Trust Principles.
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