Analyst Report Trashes Fannie and Freddie

Fannie Mae and Freddie Mac shares each fell more than 21 percent yesterday after analysts at Keefe, Bruyette & Woods said their common stock was worthless even if the troubled government-sponsored enterprises end up being recapitalized by the banking industry.

The freefall threatens to hamper and even cripple government efforts to stave off foreclosures, keep interest rates low, restore confidence in the mortgage backed securities markets, and finance new initiatives like the new temporary bond and refinancing program for state and local housing finance agencies announced yesterday.

KBW analysts downgraded shares of Fannie Mae and Freddie Mac to underperform from market perform and cut their price target on both stocks to zero from $1.

"In order for the government-sponsored entities to survive going forward, we believe they need to be recapitalized through investments from the banks that benefit from their role in the secondary market," KBW wrote in a research note.

"In this scenario, both the common and preferred equity of the GSEs should be worthless," they said, adding that since being put into receivership last summer, the U.S. has put $98 billion of capital into Fannie and Freddie.

"Fannie Mae and Freddie Mac have been at the heart of the U.S. housing boom, bust and recovery," KBW said. "As the mortgage market moves away from crisis mode, the future of the GSEs has to be addressed." In September 2008, Fannie and Freddie were placed into the conservatorship of the Federal Housing Finance Agency.

Fannie and Freddie accounted for 68 percent of all mortgage originations in 2009 as they stepped in to provide credit during the lending crunch.

However, they are being hit by ongoing mortgage losses and higher borrowing costs during the housing downturn. Fannie reported a second-quarter loss of nearly $15 billion, after it lost more than $20 billion in the first quarter.

Both companies reported rising delinquencies this summer. Nearly one out of twenty mortgages guaranteed by Fannie Mae was seriously delinquent in July and its rate on single family mortgages jumped 0.23 percentage points to 4.17 percent in July, higher than it has been in the 11 years for which records are available. A year ago, the delinquency rate was 1.45 percent. Freddie Mac's mortgage delinquency rate for its single family mortgages rose for the 28th straight month in August, reaching a record 3.13 percent of its portfolio 1.11 percent in August 2008.