Fannie and Freddie getting shakier?

November 20, 2007

A recent story in Fortune magazine rattled some cages over the weekend, as analysts are now questioning a new methodology that FannieMae uses to summarize bad loans on its books; had it continued with its old system, the loss ratio would now be beyond the 0.4% to 0.6% range (or 4 to 6 basis points) that's typical for the home loan giant.

According to Fortune writer Peter Eavis, "Management acknowledges that credit losses are mounting. During an analyst call last week, Fannie Mae CEO Daniel Mudd warned that the company's loss ratio could rise to eight to 10 basis points in 2008, due to a worsening housing market. It's not clear whether that forecast is based on the old or new methodology.

The company may already be exceeding that 2008 guidance. Based on the old methodology for calculating the loss ratio for the third-quarter alone, the company's annualized loss ratio is already at 14 basis points.

If so, Fannie Mae's mounting losses are disturbing.

So what could a soaring loss ratio mean for Fannie Mae? Consider these numbers: At Sept. 30, Fannie Mae had exposure to $74 billion of loans with a FICO credit score below 620. Loans scored below 620 are generally classified as subprime. In addition, Fannie Mae has exposure to $196 billion of Alt-A mortgages, home loans for which the borrower doesn't have to submit complete documentation for basic criteria like income.

At the same time, Fannie Mae has only $40 billion of capital."

A few days later, little brother FreddicMac announces its own $2 billion loss and seeks new cash infusions, which is even more troubling since that loss was much larger than the much larger FannieMae's $1.4 deficit at the end of its recent quarter.

Is it possible that FannieMae's deficit is actually far greater than the $1.4 billion it reported?

According to the recent AP story, "The two 'have provided essential liquidity in a time of crisis,' Fox-Pitt, Kelton analyst Howard Shapiro said in a research note Tuesday. 'Now that that liquidity function has essentially been withdrawn, it will mean, in our opinion, a further exacerbation of the housing downturn - even less credit available and steeper downturns in home prices.'

Underscoring that mindset was a 6.2% decline in Countrywide stock, which has been heavily dependent upon the two GSE (Government Sponsored Entity) groups to buy its loans.