Fannie and Freddie debt gains as deep share dive abates

NEW YORK (Reuters) –

Investors’ growing belief in the

likelihood of a federal bailout of home-funding giants Fannie

Mae (FNM.N) and Freddie Mac (FRE.N) triggered a rally in the

debt prices of the two companies on Thursday while a steep fall

in their shares prices abated.

Debt investors bet the securities will get a U.S. guarantee

even if shareholders are wiped out by a federal rescue of the

two government-sponsored enterprises (GSEs), which own or back

almost half of all outstanding U.S. mortgages.

“The debt is selling right now because the bond market

thinks the government is going to step in and take over,” said

Paul Miller, managing director at Friedman, Billings, Ramsey in

Arlington, Virginia. “If the Treasury continues to hold their

breath, debt spreads will widen back up” versus Treasuries.

“I do not think it (government intervention) is going to

happen this weekend. I do not know if it is going happen within

the next couple of weeks,” said Miller. “The more the stocks

trade down, the higher the probability they will have to act. I

do not think $3 is that trigger point, but it is certainly

getting there.”

Shares of Fannie Mae and Freddie Mac erased earlier losses

of about 20 percent as growing speculation of an imminent

government bailout forced investors to buy back shares to exit

bets made in hopes of a further decline.

Freddie shares fell 2.8 percent to $3.16 while Fannie

gained 10.2 percent to $4.85. So far this week, Fannie shares

have fallen 39 percent and Freddie is down 46 percent.

The two GSEs have reported losses for the past four

quarters, and rising mortgage delinquencies cut into the value

of their assets and capital. However, they meet regulatory

capital requirements and are successfully rolling over their

debt on the regular schedule, limiting the need for any

nationalization by the government.

As the United States suffers the worst housing market

downturn since the Great Depression, the two GSEs’ ability to

fund mortgages through the issuance of debt is considered

crucial for the housing market and economy.

As the share prices evaporate, banking sector analyst Dick

Bove of Ladenburg Thalmann in Florida said, the government

should recruit financial industry leaders to oversee

dismantling of the two companies.

“The only rational action” to be taken relative to Fannie

and Freddie “is to get rid of them,” Bove wrote in a research

note.

The price of the debt issued by Fannie and Freddie has

surged relative to U.S. Treasuries in the past two days,

however, on the view that Congressional backing for a bailout

mandated in July this year will secure repayment.

Investors are closely watching the performance of the

companies’ debt, given that the two GSEs will need to roll over

$225 billion of debt by the end of September, according to

Barclays Capital.

“If they are able to roll over their debt in late

September, and the dollar amount is substantial, then it

signals that the credit markets are comfortable enough with the

current situation and with the government backstop and that

buys them a fair amount of time,” said Brian Gardner, chief

political analyst for Keefe, Bruyette & Woods.

“If that does not turn out well, then the Treasury, if they

have not already done so, will at that point be forced to step

in and act more quickly than they would have,” he added.

Both agencies have demonstrated in debt sales this month

that they still have ready access to the capital markets,

albeit at a higher cost.

The ongoing ability of the GSEs to finance the purchases of

mortgage from private lenders, freeing up money for more

lending, is critical to the housing market. Many of Fannie’s

and Freddie’s private competitors shut their doors after record

foreclosures on riskier loans in the past year.

A new Freddie Mac five-year note was sold on Tuesday at

record 1.13 percentage point yield premium over Treasuries. The

pricing enticed enough demand to cut that premium to 0.98

percentage points on Wednesday and about 0.90 percentage point

at on Thursday.

However, a bounce in the two companies shares prices could

be expected if the government acts to support the two largest

U.S. home funding companies without eliminating value for

existing shareholders.

But the market is demanding clarity and without it the

shares are vulnerable.

“Nobody is going to put equity capital or preferred stock

into Fannie and Freddie, with ‘what’s the government going to

do?’ hanging over your head,” said Robert Napoli, analyst Piper

Jaffray in Chicago.

One option for the regulator of the GSEs is to waive the

requirement that Fannie and Freddie hold excess capital, he

said.

“If the government were to provide support that didn’t wipe

out shareholders … you will have another year of bad

quarters, and it then starts getting better so there’s a lot of

upside potential,” said Napoli. “There’s that possibility out

there.”

The Treasury could also take an equity stake in the

companies, buy their mortgage-backed securities or senior

agency debt, and ultimately restructure Fannie and Freddie,

analysts said.

The Wall Street Journal reported late on Thursday that

Freddie executives are sounding out private-equity and other

investors about buying new common and preferred shares, but

said such efforts faced investor fears that a bailout involving

an equity purchase would dilute the value of any investment.

(Additional reporting by Al Yoon, Walter Brandimarte, Julie

Haviv; Editing by Gary Hill)