A company with a $2.8 trillion potential problem
We have been very critical of some financial governmental authorities of late, some say too critical. Here’s another dose. Fannie Mae, which is both sponsored by and regulated by the federal government, has guaranteed some $2.8 trillion, or 23% of all US residential mortgage debt. The only problem is that Fannie Mae itself might be insolvent. Barrons:
Fannie Mae…occupies a curious middle ground between the public and private sector as a result of its privatization in 1968 as a Government Sponsored Enterprise, or GSE. While owned by its shareholders, Fannie is regulated by a government agency and is able to borrow money cheaply, thanks to an implicit guarantee by Uncle Sam. It uses those funds to buy and securitize home loans — lots of them. At year end, the company owned in its portfolio or had packaged and guaranteed some $2.8 trillion of mortgages or 23% of all U.S. residential mortgage debt outstanding.
Of late, however, Fannie’s prospects have darkened notably. The company (ticker: FNM) lost $2.6 billion last year as a surge of red ink in the final two quarters more than wiped out a nicely profitable first half…
In the wake of margin calls on collateral at the investment concern Carlyle Capital, yields on guaranteed mortgage securities issued by Fannie and its GSE sibling Freddie Mac (FRE) rose to their highest level over U.S. Treasuries in 22 years. Likewise credit default swaps, measuring market concerns over the safety of Fannie corporate debt, have ballooned out to 2% of the insured amount from 0.5% just four months ago…
a considerable portion of Fannie’s losses also came from speculative forays into higher-yielding but riskier mortgage products like subprime, Alt-A (a category between subprime and prime in credit quality) and dicey mortgages requiring monthly payments of interest only or less. For example, Fannie’s $314 billion of Alt-A — often called liar loans because borrowers provide little documentation — accounted for 31.4% of the company’s credit losses while making up just 11.9% of its $2.5 trillion single-family-home credit book…
At year end, the company reported regulatory net worth of $45.4 billion, some $3.9 billion higher than the expanded minimum capital of $41.5 billion required by federal regulators. But with its extreme leverage — assets stand at 20 times net worth — Fannie has little room for error. And there appear to be significant problems with the way Fannie has valued both its assets and liabilities. For example, some $13 billion of its $45.4 billion in net worth consists of deferred tax assets that have value only if Fannie can earn enough money in the near future (say $36 billion) to employ them…
There’s an item called guaranty obligation, which represents the company’s best estimate on what it will have to pay out to make good on any mortgage defaults in its $2.4 trillion guaranty book.
On its regular balance sheet, Fannie carries the item at $15.4 billion, but on its “fair value” balance sheet, which attempts to mark every asset and liability to current market value, the guaranty obligations are pegged at $20.6 billion…Freddie went through the exact same drill with its guaranty obligations’ fair value and chose to mark them much more aggressively. It valued them at 1.5% of its guaranteed book, double the 0.74% of total book that Fannie saw fit to use, even though Freddie’s delinquency rate is lower than its rival’s. Had Fannie taken a similar hit, its fair-value net worth would’ve shrunk by some $20 billion to a paltry $16 billion…
Fannie seemed to have been inordinately easy on itself when, in the fourth quarter, it wrote down its $74 billion holdings of privately packaged, non-agency subprime and Alt-A mortgage securities by a mere 6%, or $4.6 billion…Had Fannie charged off the remaining $3.2 billion that would have torched most of the $3.9 billion in excess regulatory capital that it held at the end of the fourth quarter.
Marketwatch notes that other financial analysts take issue with the Barrons analysis: “Analysts at Bear Stearns didn’t buy into the Barron’s story, saying it ‘did not contain a complete or balanced picture,’ in a research note Monday.” But the pessimistic Jim Cramer, who has been more right than wrong since the credit crisis began, noted: “unless the Treasury comes out and says that while it may not back the common stock holders of Fannie Mae, it does back the ‘function’ of what FNM does, we are not going to be able to get through the collapse of these two stocks — which I believe is going to happen — without a depression.” Feel free to weigh the conflicting assessments as you like.
March 11th, 2008 at 12:31 pm
Cramer changes his story every day. I would never say he is more right than wrong because he takes every position on an argument. That way he can say he is right no matter what happens.