Freddie debt sale eases concerns of nationalization

NEW YORK (Reuters) - U.S. mortgage finance company Freddie Mac easily sold $2 billion of short-term debt on Monday, helping to reassure investors that both Freddie Mac and Fannie Mae can fund operations without a government bailout.

Freddie Mac stock gained 17 percent and Fannie Mae shares rose 3.8 percent, while the benchmark U.S. S&P500 stock index ended down nearly 2.0 percent.

The two government sponsored enterprises (GSEs) that own or guarantee nearly half of all U.S. mortgages have lost money for the past four quarters as mortgage delinquencies rise. But both companies currently meet regulatory capital requirements and are rolling over their debt on schedule, at higher yields.

As U.S. house prices continue to fall the U.S. administration is relying on the two GSEs to fund mortgages through the issuance of debt to support the housing market.

Freddie Mac on Monday sold $1 billion each in three- and six-month bills, with bids stronger than its sale earlier this month. Freddie Mac and Fannie Mae must routinely issue debt to refinance maturing issues that fund their combined $1.5 trillion in mortgage investments.

“The GSEs continue to have access to funding,” said Rajiv Setia, a strategist at Barclays Capital in New York. If higher rates are paid for that funding, it will get passed on through higher consumer mortgage rates, however, he said.

Fannie Mae will test the waters with a sale of $2 billion in bills on Wednesday this week.

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Investors fear that as mortgage defaults rise and erode the two companies’ capital, the U.S. Treasury will be forced to intervene, as mandated by Congress in July, by either buying stock or debt in the two companies, diluting the value of existing stock.

Citigroup analyst Bradley Ball, who has held a “buy” rating through months of turmoil surrounding the GSEs, challenged that premise.

“The recent GSE sell-off has been surprising, since the only catalyst was apparently a press report suggesting that federal officials are likely to recapitalize the GSEs soon,” Ball wrote. Nationalization is unlikely, he said.

Citing an unnamed source, Barron’s last week reported a government recapitalization of Fannie Mae and Freddie Mac was increasingly likely and that losses could go beyond common stock to preferred shares and subordinated debt.

U.S. presidential candidate Barack Obama on Monday told voters in Iowa that the government cannot allow the companies to collapse, but he also criticized the companies for expecting U.S. taxpayers to come to their rescue after they profited during the housing boom.

Citigroup’s Ball increased his “risk” rating on the two companies to “speculative” from “high,” while keeping a “buy” on the shares. Ball slashed his target prices on Fannie Mae and Freddie Mac by more than half to $9 and $6, respectively.

The headquarters of Freddie Mac are pictured in McLean, Virginia, May 14, 2008. REUTERS/Jason Reed

Ball wrote that options for U.S. Treasury Secretary Henry Paulson and the companies include an equity investment by the Treasury, a loosening of capital surplus requirements by their regulator, a sale of mortgage bonds to free up capital, or waiting until market conditions improve.

“We continue to watch market developments,” U.S. Treasury spokeswoman Brookly McLaughlin, told reporters. “We continue to be in touch with the companies and their regulators and continue to stay on top of this.”

The U.S. Treasury still believes that the mortgage finance giants should remain shareholder-owned, a source familiar with Treasury thinking told Reuters on Friday.

McLaughlin said that the Treasury’s new GSE adviser, Morgan Stanley, was not expected to issue a formal, public report on its recommendations to the Treasury regarding its temporary backstop authority. Rather, there would be “exchanges of information” between Morgan Stanley and the Treasury through the end of Morgan’s contract in January.

The fall in Freddie Mac’s stock over the past few months has made it difficult for Freddie to raise $5.5 billion in capital as planned, since investors would see their holdings severely diluted, and could risk their entire investments based on some scenarios of government takeover.

But two prominent investors, Bill Gross of Pacific Investment Management Co. and Dan Fuss of Loomis Sayles, in Friday interviews with Reuters pledged to participate in preferred stock sales if the Treasury was also a buyer.

Fuss urged the companies to each issue $15 billion in convertible preferred stock that would act like a “long term call on the common stock.”

With reporting by Julie Haviv and Jennifer Ablan in New York and David Lawder and Patrick Rucker in Washington