Category: Fannie Mae

Fannie Mae losses spike

Fannie Mae reported earnings this morning where losses exceeded street estimates by a wide margin.

The first-quarter net loss was $2.57 a share, Fannie Mae said in a statement today. Analysts were anticipating a loss of 64 cents, the average of 12 estimates from a Bloomberg survey.

Based on comments from several analysts many predict losses will actually increase going forward as home price decline estimates were raised for the second time in 4 months today.

Fannie Mae told analysts to expect bigger credit losses in 2009 and said it sees U.S. home prices falling 7 percent to 9 percent this year, up from its previous estimate of 5 percent to 7 percent. Executives see U.S. home prices eventually tumbling by an average of as much as 19 percent before starting to recover.

“There are certain things that we can’t control, like home prices and the overall condition of the economy, and until they improve, they will be a drag on our old book,” Chief Business Operator Rob Levin told analysts during a conference call today. `

`They are now starting to realize the fact that their credit losses will be considerably higher than they were in 2007,” said Ajay Rajadhyaksha, head of fixed-income strategy for Barclays Capital, who is based in New York. “Things in the housing and credit markets are deteriorating very fast.”

Of course none of this matters to OFHEO, the regulatory body for the government sponsored entities, as they lowered capital requirements from 20% to 15% today, assuming Fannie can raise another $6 billion in fresh capital.

Office of Federal Housing Enterprise Oversight said it will lower surplus capital requirements to 15 percent from 20 percent to allow the company to buy and guarantee more mortgages, its biggest source of profit.

Wouldn’t it be prudent to raise capital requirements for the GSEs since balance sheets are actually becoming more precarious?

Fannie Mae boosted estimates for credit losses this year to a range of 13 basis points to 17 basis points, up from a range of 11 basis points to 15 basis points. Every basis point, or 0.01 percentage point, is equivalent to 15 cents of earnings a share, according to Morgan Stanley analysts.

The fair value of assets dropped to $12.2 billion last quarter from $35.8 billion in December. Shareholder equity, which measures how much money would be left to stockholders after Fannie Mae pays all its bills, dropped to less than zero for common stockholders for the first time in at least 15 years, from $20.5 billion in the fourth quarter.

Fannie Mae listed $56.1 billion in so-called Level 3 assets, a category which indicates the holdings are so illiquid that they can only be priced using the firm’s own valuation models.

My Comments: So the playbook is now readily apparent for the mortgage fiasco conclusion: Fannie, Freddie and the FHLB will continue to soak up most of the $12 trillion mortgage market while shareholders will be left holding the bag. Another successful mission for the interventionists.

Fannie Mae on life support

Several weeks ago Fed Chairman Ben Bernanke floated the idea of allowing Fannie and Freddie to temporarily lift loan limits with the assistance of the US taxpayer, I mean government. Charles Schumer of course took to this like a horse to water and immediately worked on a bill to stem foreclosures. Since that time, the ever so punctual Fannie Mae corporation finally filed quarterly financials using some past accounting from ex CEO Franklin Raines. According to a recent Fortune article written by our friend Peter Eavis, Fannie has quietly changed the way they compute their credit loss ratio or the number of bad loans as percentage of total.

In August, Fannie Mae predicted its credit loss ratio would be 0.04-0.06 of a percentage point for all of 2007. A range of four to six basis points may not sound like a big deal for an institution involved in mortgages, but for Fannie Mae it is the norm. What matters is if Fannie Mae goes above that range. And Fannie Mae appears to have already done that this year.

Last week, as part of its earnings report, Fannie Mae revealed that the company had changed the way it calculates the credit loss ratio. Under the new method, Fannie Mae’s annualized credit loss ratio was just 4 basis points in the first nine months of the year.

So what would have happened if the company had compared apples to apples — and stuck with the old method of calculating its loss ratio? Under the previous method, Fannie Mae would have been well outside of its range. The company would have reported an annualized loss ratio of 7.5 basis points in the first nine months of this year.

Management acknowledges that credit losses are mounting. During an analyst call last week, Fannie Mae CEO Daniel Mudd warned that the company’s loss ratio could rise to eight to 10 basis points in 2008, due to a worsening housing market. It’s not clear whether that forecast is based on the old or new methodology.

Ominous signs of the house of cards built by former CEO Franklin Raines?

The company may already be exceeding that 2008 guidance. Based on the old methodology for calculating the loss ratio for the third-quarter alone, the company’s annualized loss ratio is already at 14 basis points.

So what could a soaring loss ratio mean for Fannie Mae? Consider these numbers: At Sept. 30, Fannie Mae had exposure to $74 billion of loans with a FICO credit score below 620. Loans scored below 620 are generally classified as subprime. In addition, Fannie Mae has exposure to $196 billion of Alt-A mortgages, home loans for which the borrower doesn’t have to submit complete documentation for basic criteria like income. At the same time, Fannie Mae has only $40 billion of capital.

My comments: This week Deutsche Bank analyst Mike Mayo estimated a default rate of 30-40% and a loss rate of 40-50% on subprime mortgages. Using the midpoint of both ranges, this implies a realized loss rate of 15.75% of principal (0.35 x 0.45). If Mayo is accurate the subprime/Alt-A exposure alone wipes out Fannie Mae’s equity.

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