Freddie and Fannie: So Bad They're Good?

Includes: FMCC, FNMA
by: Bruce Krasting

Freddie Mac (FRE) had a good day. Up 130%. Its poor sister Fannie Mae (FNM) was up a more modest 50%. This big up move comes on the heels of an after the market release on Friday of 2nd quarter earning at FRE. These numbers actually showed a gain. After taking into account the Senior Preferred dividend that is owed to Uncle Sam, Freddie of course showed a loss. That loss would have been much larger if it had been current on the other preferred shares outstanding (the public Pref.) The losses at Freddie would have been staggering if they had taken adequate reserves on their troubled loan portfolio.

Both Fannie and Freddie have now posted their second quarter statements. Two numbers jump out:

  • The total of troubled loans at the agencies is now $1.4 trillion or 30% of all loans.
  • The notional value of derivatives outstanding is equal to $2.9 Trillion.

The following slides are from F/F. They show their holdings of troubled loans. Those numbers include:

Negative amortization……….12b
Interest Only…………………… 30
Low FICO < 660………………585
Sub Prime…………………………..8

Totals:…………………………...$1.4 Trillion

The Agencies have very large interest rate derivatives outstanding. The combined book is $2.85 Trillion. Most of this activity is concentrated on just a few days of any given month. When they come to the market with these big trades, it adds to volatility. This is increasing the cost that the taxpayers are paying to fund our $2 trillion deficit. A fair question to ask is, “Who are they doing these trades with and how much are those counter-parties making while executing this big order flow?”

The first two slides show FNM's derivative book and their losses ($2b). The third and fourth look at FRE. They had a gain of 2.4b. Without that gain they would have had an operating loss. Does this mean FRE made a big ‘rate bet’ and won? Or did FNM make a losing trade?


Fannie Losses

Freddie's Derivative Book

Freddie's Gain. Were they gambling or was this just a mis-hedged situation that they lucked out on?

The timing of the departure by Mr. Lockhart and the whispers from the Administration regarding ‘a new plan for the Agencies’ were certainly influenced by the reports that were released to the public last week. We have a systemic problem. When the other D.C. mortgage lenders (Ginnie Mae, FHA and the Federal Home Loan Banks) are included, the grand total of the government’s involvement in the mortgage market is now in excess of $7 trillion or 60% of all mortgages.

How big could the losses be at the Agencies? If half of the troubled loans were to go into default and of those, 50% of the loan balance is lost, then the cost over time could exceed $400 billion. That estimate does not include any losses from the $3.2 trillion of Prime loans in their portfolio. The potential for losses in excess of $500billion is there.

The Agency public preferred stock also traded higher on the day. There are still pricing anomalies but there is a level of convergence of pricing in the $2 range. The exceptions include the FRE-K that closed at $2.94 while the FRE-V and W are only worth $1.50. Go figure?

The FNM-S is consistently the most liquid issue. There were 1.6mm shares changing hands today, about 6X’s average. It closed at $1.90. Of note was a 300k trade of the FRE-Z and 490K trade of the FNM-S. These larger amounts seem to disappear. Those two trades are worth $1.6mm, but the securities have a face value claim of $20mm. It is not clear if there is any value in the Agency common. If there is, the evidence will be in the preferred stock.