Fannie & Freddie Update

Fannie and Freddie are still the leading headlines in the news. On Sunday, the Treasury made a major announcement that is positive for the long run viability of the two companies. While Paulson’s recommendations need approval from Congress, it appears that it will get done this week. Once completed, the implied government guarantee that was always attached to Fannie and Freddie is now an explicit guarantee. Here are the main points:

The FOMC approved access for Fannie and Freddie to the Federal Reserve Discount Window. This erases liquidity concerns for the two companies as they can go directly to the Fed to borrow short term cash. Since it has been reported that Fannie and Freddie have a combined $1.5 trillion in unpledged assets, this removes concerns about a short term liquidity crunch.

The Treasury wants to expand its line of credit to the agencies. Fannie and Freddie both currently have a line of credit with the Treasury that they can use for emergency needs. However, this is currently just a $2.5 billion line. This line was established when Fannie held just $15 billion in assets and has never been increased. Speculation is that the line may be increased to $200 billion or more.

The Treasury has asked Congress for the ability to purchase equity in both Fannie and Freddie. There is not yet an actual plan to purchase equity and the form any purchase would take is still in the air. However, if approved, concerns about Fannie and Freddie becoming insolvent and unable to raise capital are eased. The US Treasury is now the backstop, able to provide an unlimited amount of capital to keep the two companies afloat.

The market has applauded this news so far this morning. Investors have renewed confidence in Agency debt as spreads are tightening on both the debt and guaranteed MBS. Freddie Mac auctioned $3 billion worth of discount notes this morning. The auction went very well with the spread tighter than recent issues and strong demand for the issue. Now that it is evident that the government will stand behind the Agencies’ debt, there is little concern for senior debt holders. Most of our fixed income holdings are senior debt issues of Fannie or Freddie.

Fannie and Freddie stock continues to be volatile as shareholders are uncertain about the dilutive affects of any capital injected by the Treasury. This will not be known unless it gets to the point of the Treasury needing to purchase equity. It was reported that Fannie and Freddie would have to agree to terms with the Treasury before any capital injection.

The preferred stock has rallied significantly off of its lows last week. It is still trading at a significant discount and will continue to be volatile until the form of any additional capital is resolved. Any solution that indicates Fannie and Freddie can raise capital and continue to pay dividends on preferred stock will be very beneficial for the preferreds.


Ryan Craft, CFA