Freddie Mac said it will need a $13.8 billion cash infusion from the U.S. Treasury as losses stemming from home-mortgage defaults surge and its future role in the housing market becomes cloudier.The mortgage titan and its sister company, Fannie Mae, which were taken over by the government in early September, are losing ground in their mission to play a larger role in the mortgage market and to help prop up U.S. home prices. Their share of the U.S. mortgage market is falling, as lenders increasingly make loans insured by the Federal Housing Administration, rather than ones guaranteed by Fannie and Freddie.
Hobbled by uncertainty over the degree of federal government backing, Fannie and Freddie have been unable to raise money by selling long-term debt at desirable rates in recent weeks. That's forcing them to rely on riskier short-term borrowing, and preventing them from buying more home mortgages from lenders.
Their dwindling role is undercutting the Treasury's push for them to help drive down borrowing costs for consumers and to spur home purchases. Given their financial and regulatory constraints, neither company has much scope to buy large volumes of mortgages and push down mortgage rates, said Jim Vogel, an executive vice president at FTN Financial Capital Markets in Memphis, Tenn. "There is no clear path for them to be a major support for the mortgage market," he said.
That suggests that the Treasury itself, and the banks to which it is providing capital, will have to take a bigger role in providing funds for home mortgages.
Federal regulators seized control of the management of Fannie and Freddie on Sept. 6 under a conservatorship. At that time, the Treasury pledged to provide as much as $100 billion of capital to each company in exchange for preferred stock. The Treasury pledge calls for it to pony up enough capital to allow the companies to maintain a positive net worth.
Freddie's call for cash on Friday came as it posted a record loss of $25.3 billion for the third quarter, reflecting a $14.3 billion charge related to unusable tax credits. The loss left its assets of $804.4 billion about $13.8 billion below liabilities. Freddie said it expects to receive $13.8 billion from the Treasury to fill that gap by Nov. 29.
A Treasury spokeswoman noted that Treasury Secretary Henry Paulson reaffirmed Wednesday the pledge to provide capital as needed.
Fannie, which on Monday reported a $29 billion loss for the third quarter, still has a positive net worth. But it has warned that it might need a Treasury infusion by year's end.
The heavy losses at Fannie and Freddie have raised fears among some investors that the $100 billion of capital pledged to each company "may not actually be enough," said Ajay Rajadhyaksha, chief U.S. bond-market strategist at Barclays Capital in New York.
Secretary Paulson, in his update on various financial bailouts on Wednesday, said Fannie and Freddie "now operate on stable footing." But the companies themselves seem less confident. In securities filings this week, both Fannie and Freddie said it was unclear whether they would even exist after the conservatorship, which was expected to continue until they returned to financial health.
The companies also said they were running into conflicts among the various objectives set by their regulator, the Federal Housing Finance Agency, and by the Treasury. For instance, they are expected to support the mortgage market by buying more loans, while trying to minimize the need for cash from the Treasury. But buying more loans requires loading up on risky short-term debt that may prove difficult to keep raising. These conflicts "will likely lead to less-than-optimal outcomes," Fannie said in its filing.
Some executives at the companies are showing signs of demoralization. "No one knows what our business model is going to look like" in a year or two, one of them said recently. The regulator, acting as "conservator," has a veto over all major decisions.
One goal of the conservatorship was to drive down mortgage rates, but rates on 30-year fixed-rate loans conforming to the standards of Fannie and Freddie have remained in a range of about 6% to 6.75% for most of the past two months. On Friday, the average rate was about 6.2%, according to financial publisher HSH Associates, compared with 6.3% in early September, just before the rescue.
Foreign investors, long major buyers of debt issued by Fannie and Freddie, have reduced their holdings, partly because they aren't sure what the coming Obama administration and Congress will decide to do with the companies. Fannie and Freddie also will have to compete in the debt market with U.S. banks issuing bonds guaranteed by the Federal Deposit Insurance Corp.
As a result, Fannie and Freddie's debt costs have risen so much that they can no longer be assured of profitably using borrowed cash to invest in mortgage securities. In mid-2007, the yield on two-year notes issued by Fannie and Freddie was about 0.29 percentage point above comparable Treasury issues. That rose to 0.93 point in early September, and now stands at about 1.5 points, according to FTN Financial.
Freddie's loss of $19.44 a share compares with a loss of $1.24 billion, or $2.07 a share, a year earlier. The biggest factor in the latest loss was the charge of $14.3 billion to reflect the likelihood that the company won't be able to make use of tax credits listed on its balance sheet as assets. Freddie's loss also reflected $9.1 billion of write-downs in the value of mortgage securities. Provisions for credit losses rose to $5.7 billion from $1.37 billion a year earlier. Freddie also had a $1.1 billion loss from short-term unsecured loans made to Lehman Brothers Holdings Inc. a few weeks before that investment bank filed for bankruptcy on Sept. 15.
Fannie and Freddie buy mortgages from the lenders that originate the loans. They package the loans into securities and sell many of those securities to other investors. The two companies provided funding for 57% of U.S. home loans originated in the third quarter, down from 70% in the second quarter, according to Inside Mortgage Finance, a trade publication. The share of new mortgages insured by the FHA jumped to 26% in the latest quarter from just 3% for all of 2007. FHA-backed loans tend to be more affordable for people who are unable to put down a sizable down payment.
Housing and financial market conditions "deteriorated dramatically" during the third quarter, Freddie said, as house-price declines accelerated -- especially in California, Florida, Arizona and Nevada -- and unemployment grew.
Freddie is trying to find buyers for a rapidly growing number of foreclosed homes, totaling 28,089 at the end of the latest quarter, up from 11,916 a year earlier. Gross proceeds from the sale of foreclosed homes on average were 29% less than the unpaid loan balance in the third quarter, compared with 14% a year earlier. That doesn't take into account related costs, such as repairs and commissions to real-estate agents, and it excludes possible recoveries from mortgage insurance.
