Fannie, Freddie Fall on Likely Need for a Bailout (Update7)

Aug. 18 (Bloomberg) -- Fannie Mae and Freddie Mac tumbled in New York trading to their lowest levels in more than 17 years on concern the government will be forced to bail out the mortgage- finance companies, wiping out common stockholders.

Fannie slid 22 percent, while Freddie dropped 25 percent after Barron's reported that the Bush administration is anticipating the government-chartered companies will fail to raise the equity they need to offset credit losses, prompting the U.S. Treasury to act. The companies' stock market values are well below the minimum of $10 billion in capital that each would need to raise to ``have any credibility,'' Barron's said in its story.

``We agree with the call for Treasury intervention and think it is very, very likely to happen before the end of the third quarter,'' Ajay Rajadhyaksha, the head of fixed income strategy for Barclays Capital Inc., said in a telephone interview today. ``Without government help, we think there is very little chance of Freddie completing a significant capital raising.''

The government plans to recapitalize Fannie and Freddie with taxpayer money should their capital raising fail, Barron's said, citing a person in the Bush administration it didn't identify. A rescue of the companies, which own or guarantee 42 percent of the $12 trillion in U.S. home loans, would include preferred stock with a seniority, dividend preference and convertibility that would wipe out common stockholders, Barron's reported.

Treasury Secretary Henry Paulson, who on July 31 received the unprecedented authority he requested from Congress to help the companies if needed, has said a bailout won't be necessary.

``We aren't going to comment on speculation,'' said a Treasury spokeswoman, Jennifer Zuccarelli. ``As the Secretary has said, we have no plans to use these authorities.''

Housing Slump

Fannie finished the day down $1.76 to $6.15 in New York Stock Exchange composite trading, the lowest level since May 1989. Freddie fell $1.46 to $4.39, its lowest point since January 1991. Fannie has lost about 85 percent of its market value this year. Freddie's has fallen 87 percent.

``The Barron's article significantly overstates our financial situation,'' said Sharon McHale, a spokeswoman for McLean, Virginia-based Freddie. She said the company is ``adequately capitalized'' and believes ``we will get through the current housing market crisis.'' Brian Faith, a spokesman for Washington-based Fannie wouldn't comment immediately.

The companies have been battered by record delinquencies and rising losses amid the worst housing slump since the Great Depression, posting four straight losses totaling $14.9 billion. Both cut their dividends this month and announced plans to slow growth after bigger-than-expected losses for the second quarter.

Raising Capital

Freddie Chief Executive Officer Richard Syron said on Aug. 6 that the U.S. housing market is still ``searching for a bottom'' and that most of the company's expected losses have yet to be realized. The U.S. mortgage delinquency rate has set a record every quarter since March 2007 while the rate of late payers going into foreclosure is also at an all-time high, Freddie said.

Fannie was created as part of Franklin D. Roosevelt's New Deal in the 1930s, a time when the U.S. economy was struggling to emerge from a stock market crash, industrial production had tumbled 50 percent and the unemployment rate reached 30 percent. Freddie was started in 1970 primarily as competition for Fannie.

Fannie has raised $14.4 billion in new capital since last December to offset credit losses. Freddie, which sold $6 billion in preferred stock in November, is struggling to raise $5.5 billion more that that company said in May it planned to sell.

Syron said on Aug. 6 Freddie would have to pay ``double- digit'' rates to issue preferred stock, compared to the 8.75 percent Fannie paid for its preferred stock issue in May. The task is made even more difficult now that Freddie's market value has dropped to about $3 billion from $42 billion a year ago.

Puling Market Down

``If they're unable to tap the markets to raise capital, I think we're talking a matter of quarters before the government has to step in,'' Joshua Rosner, an analyst with independent research firm Graham Fisher & Co. in New York, said in an interview this month.

Both companies will need to raise as much as $15 billion, Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia, said earlier this month.

Fannie paid a record high yield in a $3.5 billion sale of three-year benchmark notes last week that drew less demand from Asia, the second-biggest buyer of Fannie's debt and mortgage- backed securities. Asian investors bought 22 percent of the issue, almost half the demand of three months ago and about two- thirds of Asia's usual buying.

Treasury data show that private and government investors in Japan slowed purchases of their debt to $770 million in June, from $4.5 billion a month earlier. China bought $9.6 billion in Fannie Mae and Freddie Mac debt, down from $14.9 billion in May.

Short Selling

Standard & Poor's cut Fannie and Freddie's preferred stock and subordinated debt ratings by three levels last week to A- from AA-. S&P affirmed the companies' AAA senior debt rating, reflecting perceived government support.

A rule that made it harder for investors to bet against Fannie and Freddie's shares also expired last week. The Securities and Exchange Commission on July 21 imposed a temporary order that tightened rules for 19 stocks, including Fannie and Freddie, prohibiting firms from so-called naked short selling, where they sell shares without actually borrowing them.

Credit-Default Swaps

The cost to protect the subordinated debt of Fannie and Freddie from default climbed to a record. Credit-default swaps on Fannie's subordinated debt increased 50 basis points to 328 basis points, while contracts on Freddie jumped 51 basis points to 328, according to CMA Datavision.

Contracts on the senior debt of Freddie increased 1 basis point to 50 basis points, while Fannie was unchanged at 49 basis points, CMA data show. The gap between the credit-default swaps on the senior and subordinated debt is the widest on record. A basis point on a contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should the company fail to adhere to its debt agreements.