Citigoup analyst Bradley Ball is sticking to his guns on Fannie Mae (FNM) and Freddie Mac (FRE). Ball continues to insist that while the two GSE’s shares are hurting, both of them won’t have problems issuing new debt. Ball:
We believe Treasury Secretary Paulson’s plan to provide a backstop for the GSEs in order to ensure their market access for debt issuance (included in the recent mortgage legislation, see below) is working. As evidence, the recent notes issued by FRE, which were oversubscribed and included 40% participation from non-U.S. investors (30% Asian) showed the success of the backstop plan, regardless of the price paid (which is more of a business issue than an access to funding issue). The $3 billion 5 year note issuance was priced at 113 bps over Treasuries, which was an unusually high price; however, once the securities were free to trade, their spread compressed to around 90 bps. We believe the success of this debt issuance reflects FRE’s solid access the capital markets and is a positive indicator of the success of the “Paulson Plan”.
Also, Ball thinks that Fannie and Freddie have a number of options available to them to weather the current turmoil, including:
- Policymakers could restate their support for both GSEs, which supposedly will appease the media vultures (not sure about that).
- Regulators could ease capital surplus requirements, which would give the GSEs more breathing room.
- Freddy and Fanny could save $3 to $4 billion by closing their checkbooks and no longer buying any new mortgages. This move would be politically difficult as it would likely force mortgage rates and credit spreads up.
- Both lenders could free up $1.25 billion by selling mortgage-backed securities to the Treasury Department.
- The firms could simply do an old-fashioned equity raise. Such a move would be damaging to current shareholders and would likely be at cripplingly high rates.
- Finally, says Ball, FNM and FRE could simply ride out the storm and wait for debt and equity markets to become more favourable.
Most of those options are unpleasant, Ball acknowledges. But since no one seems keen on actually nationalizing Freddie and Fannie, they’ll have to do:
Although we realise that these options are not necessarily politically palatable and are generally undesirable to existing shareholders, we believe they represent some remaining flexibility for the GSEs. We would also highlight that under any scenario that plays out over the coming weeks/months, our expectation is that the GSEs will continue to provide support for the U.S. mortgage market by helping maintain the market for affordable mortgages.
Ball reiterates his Sell rating on both companies and maintains his $9 price target for Fannie Mae and his $6 price target for Freddie Mac.
See Also: Bond Mogul Gross: Fannie (FNM) And Freddie (FRE) Need $40 Billion
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