Fannie, Freddie seen boosting loss estimates, again

Original Link: http://www.reuters.com/article/newsOne/idUSN0159911820080801

By Al Yoon - Analysis

NEW YORK (Reuters) - U.S. mortgage market giants, Fannie Mae and Freddie Mac, may report further downgrades to their forecasts for credit losses in their upcoming second-quarter results, starting next week.

The government-sponsored enterprises have already warned investors that credit-related losses, such as payouts on loans they guarantee, would likely rise through 2008 as falling U.S. home prices aggravate defaults on mortgages.

But the collapse in the shares of Fannie Mae and Freddie Mac last month, which led to the U.S. Treasury and Congress extending them government support, suggests investors think the companies sorely underestimated the housing market debacle.

Since the two companies' May forecasts, the U.S. housing market has continued to deteriorate, leading credit rating agency Standard & Poor's this week to raise its loss estimates on risky loans which, in turn, may extend the vicious cycle of asset write-downs at banks.

In the market's view, Fannie Mae and Freddie Mac may not have enough capital to offset losses and maintain their roles as the engines of the U.S. housing market.

"They've increased credit loss expectations for the past three quarters and this next one is probably going to be the fourth," Robert Napoli, an analyst at Piper Jaffray in Chicago, said in a recent interview.

Freddie Mac, which in May boosted its forecast for total credit losses in 2008 to 16 basis points or 0.16 percent of their total mortgage book, from 12 basis points, plans to report second-quarter results on Wednesday.

Fannie Mae in May ratcheted up its expectation for its 2008 credit loss ratio to 13 to 17 basis points, at least double its historical range, from a prior estimate of 11 to 15 basis points to 15 basis points. Fannie had not set a date for its second quarter results by Friday afternoon.

Upward revisions to loss forecasts may reignite scrutiny over whether the companies can contain their losses and meet political pressure to expand their support for the housing market. They own or guarantee nearly half of the $12 trillion mortgage market.

Doubts about their capital adequacy led to one of the stormiest months ever for the mortgage giants in July, leading the U.S. Treasury to make explicit its already tacit support for the two companies. The housing market legislation passed by Congress in July included provisions for the U.S. Treasury to buy equity capital in the two firms and extend credit to them.

Fannie Mae and Freddie Mac have said they have enough capital and their regulator, OFHEO, affirmed their statements.

S&P, whose massive downgrades in the ratings of mortgage related assets in the summer of 2007 helped to exacerbate the credit crisis, this week again boosted its assumptions of losses on subprime and so-called "Alt-A" mortgages, which require less documentation and were often handed to borrowers with no equity stake in the property.

The new assumptions indicate up to $450 billion, or 85 percent, of "AAA" rated 2006 vintage subprime securities will default, and may lead to a raft of downgrades that pressure financial institutions to face a "new reality," said Vivek Tawadey, head of credit strategy at BNP Paribas in London.

The pressure of credit downgrades for companies follows, and in turn may encourage, falling home prices. Through May U.S. house prices had already slumped 18.3 percent since the peak in July 2006, according to S&P/Case Shiller index of 20 metropolitan areas.

Deep downgrades on even the safest, "AAA" rated mortgage bonds will lead to more credit tightening due to the need to raise capital reserves and take mark-to-market losses, Tawadey said in a note about "Hurricane Housing" on Friday.

"Turbulent market conditions lie ahead, would probably be an understatement" considering the early impact from Merrill Lynch & Co and other institutions that have taken "painful steps," he said.

For Fannie Mae and Freddie Mac, further drops in home prices since the first quarter will probably force them to increase reserves by a material amount, said Moshe Orenbuch, an analyst at Credit Suisse in New York. Their reluctance to deem market losses on Alt-A and subprime mortgage bonds they own as "other-than-temporary" will be challenged, he said in a note.

The more than 40 percent drop in the shares of Fannie Mae and Freddie Mac last month, and government plans to ensure backstop funding for the companies are indicators that writedowns for the companies are more likely, he said.

Analysts surveyed by Thomson Reuters expect Fannie Mae to report a second-quarter loss of $920.8 million, or 78 cents per share, compared with a $1.83 billion profit, or $1.86 a share a year ago. Freddie Mac is seen losing $319 million, or 59 cents a share, compared with net income of $729 million, or 96 cents per share a year earlier.

A monthly disclosure from Fannie Mae this week provided another clue on credit performance, according to Thomas Lawler, founder of Lawler Economic & Housing Consulting in Leesburg, Virginia, and a former portfolio manager at the company.

Delinquencies on mortgages with "credit enhancement" increased to 3.56 percent in May from 3.33 percent in April, representing a "disproportionate" jump for certain loans, including Alt-A, he said.

Fannie Mae has about $70 billion in subprime and Alt-A securities in its portfolio. Freddie Mac is more at risk, with nearly $150 billion in the securities, analysts said.