Bill Gross: Treasury Will Have to Buy Fannie/Freddie Shares

 |  Includes: FMCC, FNMA
by: Ron Haruni

After Freddie Mac reported a second-quarter net loss of $821 million (more than triple most analysts’ forecasts), Bill Gross, one of the world’s largest mutual fund managers who focuses mostly on bonds, said on Wednesday to Bloomberg that the “U.S. Treasury will probably be forced to buy $10 billion to $30 billion of preferred shares in both Fannie Mae (FNM) and Freddie Mac (FRE) to help shore up their capital.”

Both GSEs have been under considerable pressure for awhile now, starting with losses on their portfolios of loans and mortgage securities, concerns about their derivatives exposure and the collapse of the mortgage insurance firms. But the main issue is capital.

Fannie Mae’s and Freddie Mac’s liabilities and contingent liabilities are quite large given their current capital. During the second-quarter, Freddie’s cash cushion against losses fell to $37.1 billion, or $2.7 billion above the mandatory target surplus set by its federal regulators. At the same time, its asset market value came in a negative $5.6 billion, raising again insolvency issues.

Freddie Mac Chief Financial Officer Buddy Piszel told AP that the credit problems are emerging mostly in the company’s Alt-A portfolio loans which make up 10 percent, or $190 billion, of Freddie’s entire portfolio. These are loans which contains mortgages with high risk factors like undocumented borrower income.

Meanwhile, Freddie’s Chief Executive Officer Richard Syron downplayed his concerns telling investors that his company will wait for its stock to improve before starting its planned $5.5 billion capital raising. He also and diplomatically rejected PIMCO’s Bill Gross statement, by saying “based on the information I have now, I do not believe that the Treasury will end up having to inject money into Freddie Mac.”

Whether the Treasury will become involved in re-capitalizing Freddie in the next months, remains to be seen. However, two things are for certain, Freddie and Fannie are going to cost a lot of money and a capital injection will be dilutive and will make common stock holders vulnerable.