At GSEs, Undercapitalized May Not Mean ‘Underreserved’: KBW

Although quarterly losses at the government-sponsored enterprises (GSEs) continued to mount in Q210 — requiring cash infusions in the range of billions of dollars — analysis out today indicates losses will begin to level out as the companies set aside fewer capital reserves. After Fannie Mae and Freddie Mac reported quarterly losses of $1.2bn and 4.7bn, respectively, the Federal Housing Finance Agency (FHFA), acting as the GSEs’ conservator, requested billions from the Treasury Department to cover net worth deficits at both companies. But according to analysts at investment bank firm Keefe, Bruyette & Woods (KBW), credit trends have started to show moderate improvement and losses should start declining as reserve building slows. In short, while the GSEs may appear to be undercapitalized, they are not necessarily “underreserved.” Both companies will be adequately reserved for their legacy portfolio by the end of 2010, unless there is a meaningful downturn in the economy, according to analysts led by Bose George. KBW expects cumulative GSE losses to total approximately $200bn, noting that market estimates of $400bn in cumulative losses are “overly pessimistic.” KBW analysts noted he chart below tracks potential credit losses for the GSEs under different delinquency and loss severity assumptions (click to expand): As HousingWire previously reported, Fannie Mae’s Q210 loss was smaller than the $11.5bn loss in Q110, while Freddie’s Q210 loss was narrowed from $6.7bn in Q110. The total government commitment of taxpayer dollars to the GSEs since conservatorship began on Sept. 7, 2008 now totals $84.6bn for Fannie and $63.1bn for Freddie. KBW said that given the 10% interest rate on this debt, the annual run rate of dividend payments from the GSEs to the government is just over $15bn. While “significantly negative,” KBW noted that the fair value of both GSEs equity improved during the quarter. Fannie improved to negative $138bn from negative $145.2bn in Q110, while Freddie improved to negative $46.3bn from negative $59.6bn in Q110. The negative fair value positions at both GSEs reflect the government’s contributions to keep the GSEs afloat and the senior preferred stock issued to facilitate those transactions. Excluding that, Fannie’s fair value of equity declined by $1.2bn and Freddie’s improved by $2.7bn. “We believe that the fair value of equity is far greater than our expected loss assumptions because the former is essentially a liquidation value and has to value the company’s guarantee portfolio based on what a potential buyer would pay for it,” the KBW analysts wrote. Looking forward to the future of the GSEs, KBW projects the current structure of the GSEs will eventually be wound down, wiping out current shareholders. Analysts added, however, that they expect the government to find a home for the core guarantee business of both Fannie and Freddie. On August 17, the Obama Administration is hosting a “Conference on the Future of Housing Finance” in Washington DC, bringing together industry groups, market participants, academic experts and consumer and community organizations for “an open discussion about housing finance reform.” As the process to revamp Fannie and Freddie continues, so do the companies’ mortgage losses. As REO Insider reported, Fannie’s REO volume more than doubled from Q209 to Q210, despite increased loss mitigation efforts. As for Freddie, the number of completed “foreclosure alternatives” increased 123% in the first half of 2010 year-over-year, while its REO portfolio increased 79% during the same time. The KBW analysts believe HAMP will not be very effective, projecting significant re-default rates on modified loans. Despite this, they wrote that GSE delinquency rates are stabilizing. Even with heightened levels of HAMP re-defaults, delinquency rates should remain well below KBW’s expected delinquency rate for the GSEs. Write to Austin Kilgore. The author held no relevant investments.