When Fannie Mae and Freddie Mac had their portfolio caps raised on March 1, it appeared to be a much needed shot in the arm for the moribund housing market.

However, after both GSEs announced significant fourth quarter losses, the industry is beginning to retreat from its initial optimism about how big a role Fannie and Freddie will play in a market recovery this year.

"Despite the initial euphoria I think the market is really starting to come around and think that it will be a little drawn out process," said Brian Ye, an MBS analyst at JPMorgan Securities. "It's not going to be an immediate savior to the mortgage-back securities market right away."

Ye said that the major constraint for the GSEs is not due to the size of their losses, but rather their capital problems. "A major unknown is what type of credit losses are expected to be reported the rest of the year and how will they be accounted for," he said.

The Office of Federal Housing Enterprise Oversight (OFHEO) lifted the portfolio caps that had been in place since 2006 when the GSEs announced roughly $11.3 billion in accounting errors. The OFHEO also said it would gradually lift the 30% capital surcharge for the GSEs.

The conforming loan limits for Fannie Mae and Freddie Mac were also raised up to 125% of an area's median home price, with a maximum of $729,750. The temporary lift is supposed to bring relief to jumbo loan borrowers in more expensive areas such as California.

Losses Hinder Positive Impact

But Freddie Mac announced a $3.55 billion fourth-quarter loss, while Fannie Mae lost $2.1 billion for all of 2007. Freddie is facing a possible downgrade of its bank financial strength rating by Moody's Investor Service, and Moody's is forecasting Fannie to record "sizable losses" in 1H08, and possibly a net loss for 2008.

Despite the agency's struggles, Daniel Mudd, president and chief executive officer of Fannie Mae, said in a Feb. 27 conference call with investors that the market's demand for liquidity will provide an opportunity for Fannie Mae to grow its guaranty business and portfolio. He said the company will "protect on one hand, pursue on the other hand."

In a March 4 research note UBS analysts were blunt: "Fannie and Freddie will both be capital-constrained and unable to take advantage of the lifting of portfolio caps." The analysts said the capital pressures will continue for the GSEs because asymmetric treatment of derivatives, further losses on their guaranty business and expected problems with mortgage insurers.

Countrywide Financial analysts wrote on March 3 that even with the gradual decrease of the 30% capital surcharge, "it seems unlikely that either Fannie Mae or Freddie Mac will utilize the incremental capital to aggressively build their portfolios" because of the fourth quarter losses. Fannie and Freddie both hold excess capital above the OFHEO requirement which Countrywide analysts believe will allow them to make some portfolio purchases, but they added, "we expect the amount utilized will be well short of maximum potential additions."

JPMorgan's Ye said that the lowering of the 30% capital surcharge "in theory will give them $8 or $9 billion in capital each." But he added, "Do they want to leverage that much given their recent history? I would think they would be more gun-shy about it."

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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