Thursday, August 28, 2008
easing perceptions of the GSE crisis
A recent report from Citigroup Inc. (C: 18.38 +1.43%) analyst Bradley Ball suggested similar sentiment. In a report put out last Friday, Ball characterized the most recent sell-off of shares as “surprising, since the only catalyst was apparently a press report suggesting that federal officials are likely to recapitalize the GSEs soon.”
He said that any nationalization of the GSEs was “unlikely,” although he did allow for the potential for a “Chrysler-like Federal loan.” The report also stressed that shareholders’ interest would likely be preserved, regardless, although Ball said that any near-term Treasury action was highly unlikely.
“We are not convinced that Treasury needs to take any action over the near-term,” the report said. “While the decline in the GSEs’ stock prices, if they persist, may pose challenges to any capital raising efforts down the road, the short-term stock price performance does not have any bearing on the success of the ‘Paulson Plan.’”
In other words: everyone, just calm down. ...
That’s not to say the GSEs don’t have capital constraints; they most certainly do, and those constraints are being seen in how Ginnie Mae has vaulted in front of both Fannie and Freddie in fixed mortgage security issuance during August. But most analysts well-versed in GSE watching have suggested that both companies could continue to operate in the current adverse credit market and maintain current reserving activity without putting current regulatory capital requirements at risk at least through the end of this year, or perhaps even longer.
Even then, as Citi’s Ball suggested, the GSEs are not without options; among them, HW’s sources said, is the ability of both GSEs to allow portfolio assets to run-down. While not necessarily the best outcome from a mortgage lending perspective, such a run-down would offer plenty in the way of liquidity; which means that any debate over the GSEs shouldn’t be about solvency or a nationalization that seems increasingly unlikely to take place any time soon.
a better than anticipated debt auction for GSE issues has goven some cover for optimism regarding fannie mae and freddie mac. i've read the citi research and can't say i disagree with the ground it covers -- FNM/FRE may be insolvent by a considerable margin but are certainly increasing loss reserves and can put part of the portfolio into runoff to raise cash, shrinking their retained portfolios ot the tune of $4bn a year.
the key point to feature, however, from the citi report:
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”.
spreads are way out (for "government-backed" debt) for this issue, which was after all just $3bn. but continued foreign central bank participation is essential -- close observers have noted a deep retraction from GSE issuance, and FNM/FRE have something like $220bn in debt to roll in the next month. we talk about the GSEs pushing some of their portfolio into runoff; what of the FCBs, particularly if china needs funds to stimulate its economy? and what of the nervousness of japanese holders of american debt?
wary eyes will continue to be cast at GSE auctions through september; the sanguine picture painted by citi could turn on a dime. further retrenchment on the part of FCBs will show up as wider spreads, tighter credit and higher mortgage rates, if not failed (or treasury-supported) auctions. if FCB support for GSE issuance falters meaningfully, with the GSEs already having had to reduce their efforts to support the mortgage marketplace, treasury will be faced with irresistable political pressure to intervene in an effort to pump liquidity into a crashing housing market during an election cycle.
UPDATE: bank of china is dumping FNM/FRE -- just in case treasury isn't getting the hint!