Monday, November 10, 2008

Fannie: Going Concern, but I am Getting Concerned

Fannie Mae lost a reported $29 Billion in Q3. Over the past 7 quarters, they have now lost ALL earnings associated with the housing boom.

But after the $100 Billion Treasury injection and a variety of new liquidity facilities, the future must look bright... right? Well, maybe once they get past problems associated with their soon to be negative net worth, lack of liquidity, and bad loans. Lets get some more details.

Net Worth:

Under the Regulatory Reform Act, the Federal Housing Finance Agency MUST place Fannie Mae into receivership if their assets are less than obligations for a period of 60 days (I'll believe that when I see it).

Net worth is down from $44.1 Billion as of December 2007, to a reported $9.4 Billion at the end of September 2008. Of that $9.4 Billion, almost half is deferred taxes (i.e. provides no benefit without futures earnings).

Liquidity:

This past September, the Treasury made available two additional sources of funding to Fannie Mae; the Treasury credit facility and the senior preferred stock purchase agreement (i.e. the $100 Billion). Unfortunately this hasn't helped much; according to Fannie Mae in their 10-Q:

We have experienced reduced demand for our debt obligations from some of our historical sources of that demand, particularly in international markets.
Well if you keep making the following statements, you won't need to search for a reason why:
The U.S. government does not guarantee, directly or indirectly, our securities or other obligations.
Hmm.... just a few weeks back Federal Housing Finance Agency James Lockhart declared:
A government takeover of the two companies gives the companies “access to credit from the U.S. Treasury (and) an explicit guarantee to existing and future debt holders of Fannie Mae and Freddie Mac”
What's important is that the market agrees with Mr. Lockhart, as Fannie MBS currently trades within 5 bps of Ginnie MBS, which is absolutely guaranteed by the U.S. Government. The problem is the lack of liquidity in credit markets for anything with longer dated maturites outside of Treasuries.

Managing Problem Mortgage Loans and Preventing Foreclosures:

Finally, lets review the quality of Fannie's mortgage pools. After all, we are told on Fannie's website that:
Fannie Mae first ensures that the loans it acquires generally meet its credit quality guidelines and then it securitizes the pool of mortgages.
Unfortunately, even high quality loans can become non-performing in this environment. Non-perfoming loans are almost twice the level seen just nine months ago.

Conclusion:

There is absolutely no way any Agency MBS will be allowed to fail as the outcome would be disastrous. At the same time, putting Fannie and Freddie on the Treasury Balance Sheet is not an option as there is incentive to keep up the appearance of Fannie as a "going concern" regardless of how much money they lose (this would require too much transparency). In other words, I expect the original $100 Billion to just be a drop in the bucket.