By Dawn Kopecki and Caroline Salas
July 15 (Bloomberg) -- Fannie Mae and Freddie Mac plunged on speculation Treasury's plan to support the biggest U.S. mortgage- finance companies will sacrifice common shareholders.
Fannie Mae dropped as much as 19 percent in New York and Freddie Mac declined 26 percent, following U.S. Treasury Secretary Henry Paulson's plan to avert the collapse of the mortgage firms. The cost to protect against a default on the companies' $20 billion of subordinated debt rose.
Shareholders are at risk from Paulson's plan because the government-chartered companies may require new equity after already raising $20 billion in the past year to cover losses. Washington-based Fannie Mae has slid 79 percent this year, and Freddie Mac, based in McLean, Virginia, has lost 84 percent in 2008.
``The good news is that Fannie Mae has all the capital that it needs,'' said hedge fund manager William Ackman, who has short positions in both companies and has briefed Treasury and Federal Reserve officials on a plan to reorganize them. ``It just has the capital in the wrong form with too much debt and not enough equity,'' said Ackman, who oversees $6 billion for Pershing Square Capital Management, in a telephone interview.
Paulson sought to shore up investor confidence July 13 when he said from the steps of the U.S. Treasury that he will seek authority to buy equity stakes in Fannie Mae and Freddie Mac and increase the government's credit lines to the companies. Last week, their shares fell 50 percent and credit-default swaps on Fannie and Freddie bonds approached record highs.
Fannie Mae fell $1.42 to $8.31 at 9:33 a.m. Freddie Mac declined $1.40 to $5.71.
Credit-Default Swaps
Almost 216 million Fannie Mae shares were traded yesterday in New York, 22 percent of the stock outstanding. Almost 263 million Freddie Mac shares changed hands, or 41 percent of the total.
``It's more consternation,'' said Andrew Harding, chief investment officer for fixed income at Allegiant Asset Management in Cleveland, which manages $20 billion in fixed-income assets. ``We still view them as credit-related securities.''
Ackman said he began selling Fannie Mae and Freddie Mac short on July 10, after they had already dropped about 70 percent for 2008. Since then, the stocks have dropped more than 26 percent. Ackman, 42, recommended selling MBIA Inc. shares before they tumbled 93 percent in the past year.
Credit-Default Swaps
Credit-default swap contract on mortgage lenders' subordinated debt, which would rank behind senior debt in a bankruptcy, rose 10 basis points to 185, according to Phoenix Partners Group.
Contracts on the $1.5 trillion of senior debt climbed about 3.5 basis points to a mid-price of 44.5 basis points, data from Phoenix and CMA Datavision show. They had jumped to more than 80 basis points last week.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. An increase indicates a deterioration in the perception of credit quality; a decline, the opposite. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
Implicit Guarantee
The government is depending on Fannie Mae, created in 1938 as part of President Franklin D. Roosevelt's New Deal, and Freddie Mac, formed in 1970, to help revive the home loan market. Banks and lenders worldwide recorded more than $415 billion in losses and writedowns from subprime-related securities, forcing them to restrict lending.
Congress started the companies to promote home buying and their charters give the Treasury the authority to extend a $2.25 billion credit line. Paulson wants to increase the facilities, making the government's implicit guarantee of their debt more explicit.
Freddie Mac received higher-than-average demand for a $3 billion sale of short-term debt after Paulson's announcement. The bid-to-cover ratio, which gauges demand by comparing total bids with the amount of securities offered, was more than 50 percent above the average of the past three months, according to Stone & McCarthy Research Associates.
To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net; Caroline Salas in New York at csalas1@bloomberg.net
Last Updated: July 15, 2008 09:39 EDT
