Fannie Mae (FNM) and Freddie Mac (FRE) need $10 to $15 billion each of new capital to restore investors’ confidence in their capital positions, says FBR. FBR also praises the government’s current rescue package, which eschews nationalization of the GSEs and suggests that more stringent capital requirements could help keep capital at healthy levels:
The government wants the agencies to continue to exist in their current form as shareholder-owned companies, and it does not want the GSEs to be privatized. We applaud the recent actions by the Treasury Department, which have eased the debt markets concerns about the GSEs’ liquidity positions. The GSEs will not be allowed to fail!
The best solution for everyone is for the GSEs to raise fresh equity to strengthen their balance sheets and continue to buy mortgages in order to stabilise the housing markets. The current GSEs’ capital rules are outdated, based on low levels of historical losses on mortgage assets. Larger capital requirements, either imposed by regulators or by market participants, could increase the amount of capital to be raised. We estimate that the GSEs need to raise $10 billion to $15 billion each-likely in $5 billion to $10 billion increments-but it will depend on size and the timing of losses on their credit book.
FBR maintains its Underperform rating on both stocks and lowers its price target on FNM from $23 to $11 and FRE from $17 to $7. FBR sees huge dilution and negative earnings all the way through 2011:
Our deep discount valuation reflects the lack of visibility regarding the companies’ capital structure. Price-to-earnings valuation is meaningless, as we expect earnings to be negative throughout 2010-2011. We believe most investors are valuing the GSEs on future earnings potential in 2010-11, but, in our opinion, this is a risky investment policy, and there are too many unknowns with credit losses and possible future capital raises.