The government seizure of Fannie Mae and Freddie Mac and the U.S. Treasury's pledge of $200 billion in funding represents explicit federal support of the companies' debt and mortgage-backed securities, Federal Housing Finance Agency Director James Lockhart said.
``The conservatorship and the access to credit from the U.S. Treasury provide an explicit guarantee to existing and future debt holders of Fannie Mae and Freddie Mac,'' Lockhart told the Senate Banking Committee in testimony today from Washington.
The comments are Lockhart's strongest yet in his efforts to combat doubts by investors about his commitment and that of Treasury Secretary Henry Paulson in standing behind the debt. The extra yield investors demand to own Fannie and Freddie corporate debt versus U.S. Treasuries fell today after his comments.
``It's a clear move by the government to try to verbally reinforce the relationships with the government without taking any other action,'' Margaret Kerins, managing director of agency debt strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut, said. ``I think at some point the market will see through that, and force Paulson to say something, or fade it.''
The difference between yields on Washington-based Fannie's five-year debt and similar-maturity Treasuries narrowed 3.7 basis points to 115.4 basis points at 12:32 p.m. in New York after reaching their highest levels on record last week, according to data complied by Bloomberg. The gap between Freddie's five-year notes and Treasuries narrowed 2.5 basis points to 120.3 basis points. A basis point is 0.01 percentage point.
Stop Trading
Jim Vogel, the head of agency debt research at FTN Financial Group in Memphis, Tennessee, urged his clients not to trade on the news until there is a legal clarification about a guarantee.
``You must NOT believe what Lockhart says'' until seeing more evidence, Vogel wrote in a note to clients. ``Lockhart might be reflecting some pending change in outlook, but the better conclusion is he is using language that means one thing in his mind but another to traders.''
E-mails to FHFA spokeswomen Stefanie Mullin and Corinne Russell seeking clarification on Lockhart's comments weren't immediately returned.
Yield spreads on Fannie and Freddie's five-year debt widened as much as 30 basis points, or 0.30 percentage point, last week as Paulson said the Federal Deposit Insurance Corp. will fully guarantee new bank debt, presenting investors with a potentially more attractive investment.
Though Paulson agreed to offer capital and financing to Fannie and Freddie to protect their debt and mortgage bonds from default as part of the September takeover, investors still say the federal backing is ambiguous.
Settle Down
``Up until this week, we haven't heard Lockhart say `explicit' before and we certainly haven't heard Paulson say `explicit,''' Kerins said. ``They're trying to put the GSEs back on par with where this FDIC-backed paper is coming.''
``Nothing has changed though,'' she added.
Lockhart tried to reassure investors on Oct. 20, telling lenders at the Mortgage Bankers Association's annual conference in San Francisco that the government has already ``effectively'' guaranteed the debt. The financial commitment ``provided the full support of all Fannie and Freddie securities,'' Lockhart said.
``It's my hope that as the markets settle down that investors will realize the strength of the U.S. government commitment'' to Fannie and Freddie, Lockhart said then.
While Paulson's agreement doesn't expressly give the companies' obligations the ``full-faith-and-credit'' of the U.S. government, it waives the Treasury's federal immunity from liability. That gives corporate debt and mortgage bondholders the right to sue the Treasury in the U.S. Court of Federal Claims on Fannie and Freddie's behalf in the event of a default.
Loan Modifications
Lockhart today also said FHFA is pushing Fannie and Freddie to work harder at modifying their troubled single- and multi- family mortgages to curtail foreclosures.
FHFA has taken on the role of a ``federal property manager,'' working to implement a plan with the Treasury that ``maximizes assistance for homeowners to minimize foreclosures'' Lockhart said in his testimony. He said FHFA will encourage mortgage servicing companies to modify troubled loans.
Fannie and Freddie, which own or guarantee 40 percent of the $12 trillion in U.S. residential mortgages, began pulling away from the market in August to preserve capital after $14.9 billion in losses over four quarters. Their inventory of foreclosed homes jumped 43 percent in the first half, their success in resolving delinquencies fell, and they took on fewer loan modifications and workout plans for borrowers, FHFA said in a report yesterday.
``A key reason for moving quickly to conservatorship was that the companies' abilities to serve their mission had been impaired,'' Lockhart said in his testimony. ``Ceasing new business activity and shedding assets was not acceptable.''
Loss Mitigation
The companies are expected to post more losses when they report third-quarter earnings next month, and analysts surveyed by Bloomberg don't expect either Fannie or Freddie to turn a profit at least through the end of next year.
The companies' inventory of foreclosed homes jumped to 76,154 at the end of June from 53,187 properties, according to the report released by FHFA yesterday. The number of borrowers entering so-called workout plans to bring their mortgages current dropped 10.4 percent from the first quarter to 10,740.
The success rate of loans in loss mitigation declined to a 37.2 percent rate from 43.7 percent in the first quarter, the report shows. Loss mitigation includes temporarily restructuring payments, modifying loan terms and charging off a portion of the principal.
``While FHFA commends the enterprises for their efforts, it is evident more can be done,'' Lockhart said.
Lockhart, who sits on a five-member board overseeing Treasury's $700 billion Troubled Asset Relief Program, said the companies can use the TARP's insurance program to help ``facilitate'' even more loan modifications.
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