How Low Can Fannie And Freddie Go?

Freddie Mac (NYSE:FRE), the nation's second largest buyer and backer of home mortgages, reported record quarterly losses on Thursday as it continues to reel from troubles in the housing and mortgage markets. This came one day after big sister Fannie Mae (NYSE:FNM) reported a worse-than-expected loss, as well.

Both companies cited rising default rates and continued problems in their portfolios, hardly a surprise given the ill-health of the housing markets. (For a one-stop shop on subprime mortgages and the subprime meltdown, check out the Subprime Mortgages Feature.)

Losses Go From Bad To Worse
Fannie and Freddie have been reporting troubles for quite some time now as the subprime crisis and plummeting housing markets have led the values of the mortgage portfolios to sink. Other similar government started loan companies, like Sallie Mae (NYSE:SLM) have been slammed by the credit crunch even without any mortgage exposure.

For its fourth quarter Freddie Mac reported a loss of $2.5 billion ($3.97 per share). Fannie Mae reported a $3.6 billion loss for its quarter, amounting to a $3.80 loss per share. These numbers are on top of the $1.2 billion and $1.5 billion that Freddie and Fannie lost respectively in the previous quarter. The problems are already widely known, but the numbers were still much graver than analysts expected. Both stocks have dropped more than 55% in the last six months, and even though they're companies the government would rescue in a doomsday scenario, I'm against buying them. The markets rejoiced in December with the government's plan to help the mortgage market, but even then Freddie and Fannie didn't look attractive.

Struggling For the Future
During Freddie Mac's conference call, management said the company has sufficient capital to move forward, since it has already secured billions in the recent months. The company said it would only need to raise more capital if the mortgage market becomes drastically worse than it is now. Let's hope not! This is decent news, as raising more capital will just keep diluting the value of the company's equity. On the other hand, what we end up with is a company that will limp along sideways or will continue to go lower.

The good news for the economy and for the stocks is that on Wednesday, a federal regulator announced the long-standing portfolio caps on Freddie and Fannie will be lifted. This will allow the companies to expand their portfolios, and become bigger players in the recovery of the mortgage and credit markets. The lift on the ban will occur March 1, and will hopefully help the companies and the markets. The effect on Freddie and Fannie directly, though, might be minimal because the companies need to maintain large cash cushions to protect against the risk in their portfolios. No matter the impact, I think Freddie and Fannie will be hurting for a while.

The Bottom Line
Just when you think things can't get any worse for Freddie Mac and Fannie Mae, they somehow manage to dig the pit a little deeper. The latest losses far outstripped analyst estimates, and the companies are continuing to experience climbing default rates. Despite marginally positive news that their portfolio caps will be lifted, I feel these companies will be licking its wounds for a while. I continue to recommend steering clear of the stocks, until there is a drastic change in the U.S. housing market.

To read about potential economic dangers posed by these two organizations, see Fannie Mae And Freddie Mac, Boon Or Boom?