On July 7th, FNMA (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) stock declined over 15% each to 14 year lows, primarily based on capitalization concerns. A Lehman Brother analyst surmised that an accounting rule change (FASB) would require the two GSEs (Government Sponsored Enterprises) raise as much as $75 billion in additional capital to meet the new capital requirements.
As it turned out, that same analyst conceded that the possible rule change would not apply to either GSE and that they would be exempt from having to raise the additional capital to meet the requirement. Unfortunately for investors of both GSEs and for the GSEs themselves, the damage had been done. On Wednesday, July 9th, FNMA issued $3 billion in two-year notes and paid the highest spread to date on those notes. The yield spread to comparable U.S. treasury securities was 74 basis points (0.74%). By way of comparison, last month FNMA issued $4 billion in two-year notes and the spread to comparable U.S. treasury securities was 65 basis points.
What does this mean? Basically, it is costing FNMA more to raise capital today compared to yesterday. This raises their cost of capital and to maintain their profit margin, it means higher rates for investors and therefore higher rates for borrowers who want to purchase a new home or refinance their current home.
If both GSEs have implied government backing, that presumably means the U.S. Government would not let them fail, why is there so much fear on the "Street" about their well-being? It could be that the "Street" does not believe the Government would come through and bail either out in the unlikely event that they fail. Or, it could be that the investing community views a worst-case scenario equating to a Government bail-out with no remaining equity for investors. I am not sure what, if anything, will come to pass, however, the credit markets are giving their own interpretation of FNMA's well-being and it's not very positive.
As it turned out, that same analyst conceded that the possible rule change would not apply to either GSE and that they would be exempt from having to raise the additional capital to meet the requirement. Unfortunately for investors of both GSEs and for the GSEs themselves, the damage had been done. On Wednesday, July 9th, FNMA issued $3 billion in two-year notes and paid the highest spread to date on those notes. The yield spread to comparable U.S. treasury securities was 74 basis points (0.74%). By way of comparison, last month FNMA issued $4 billion in two-year notes and the spread to comparable U.S. treasury securities was 65 basis points.
What does this mean? Basically, it is costing FNMA more to raise capital today compared to yesterday. This raises their cost of capital and to maintain their profit margin, it means higher rates for investors and therefore higher rates for borrowers who want to purchase a new home or refinance their current home.
If both GSEs have implied government backing, that presumably means the U.S. Government would not let them fail, why is there so much fear on the "Street" about their well-being? It could be that the "Street" does not believe the Government would come through and bail either out in the unlikely event that they fail. Or, it could be that the investing community views a worst-case scenario equating to a Government bail-out with no remaining equity for investors. I am not sure what, if anything, will come to pass, however, the credit markets are giving their own interpretation of FNMA's well-being and it's not very positive.
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