While the GSEs are expected to play a crucial role in aiding the troubled secondary mortgage market, Freddie Mac's strained financial situation could delay these efforts.

Moody's Investor Services reported on Jan.10 that it had placed Freddie Mac's A-' bank financial strength rating on review, a move that might eventually lead to a downgrade. This is based on the expectation that the company's credit losses could exceed expectations.

It's the latest setback for the agency. In November, Fitch Ratings and Credit Suisse downgraded the GSE's preferred stock after the firm announced a $4.6 billion third-quarter loss, the biggest quarterly decline ever for Freddie Mac. The firm responded by selling $6 billion in stock and slashing its dividend by 50%. It was reported that its stock has lost roughly 60% of its value over the past year.

Freddie Mac is nonetheless expected to be called upon by the U.S. Department of the Treasury to help come to the rescue if the housing market's troubles continue to spread. The timing of the action, and the GSE's role in a recovery, is difficult to determine. Freddie Mac did not return a call seeking comment.

Vincent Arscott, a credit analyst for Fitch Ratings, said that Freddie's capital infusion through its preferred stock offering was a good step in helping the company shore up its financial standing. "Freddie has forecasted pretty conservatively and built the losses in and reserved appropriately," he said. "As of now I think they would be in position to play a role in some sort of creative solution for the industry."

Freddie has instituted policy changes to minimize potential credit losses, including no longer automatically repurchasing loans that are 120 days delinquent from MBS pools. During a conference call on Jan. 7, Nicholas Strand, a manager at Barclay's Capital, called the action "particularly relevant given Freddie's goal to preserve capital in the present environment."

Fitch's Arscott added that both Freddie Mac and Fannie Mae have raised their pricing and improved their execution. "We think 2008 will certainly be challenging and our outlook for the entire non-bank finance sector and bank universe is negative," he said. "So we think Freddie and Fannie will have to endure some pain. But I think because they raised their guarantor fees and their pricing, things will begin to improve."

Fannie Mae has not gone through the same difficulty as Freddie Mac, but it has nonetheless struggled along with the rest of the market. The company reported a $1.4 billion third-quarter loss, but like Freddie, has taken steps to shore up its depleted capital. Last month, Fannie Mae sold $7 billion in preferred stock and announced on Jan. 9 that it would sell $8 billion in new two-year and five-year bonds.

Speaking at the U.S. Chamber of Commerce on Jan. 8, Daniel Mudd, president and CEO of Fannie Mae, called for raising Freddie and Fannie's $417,000 loan limit to help high-cost states where its ability to assist borrowers is constrained. Addressing Fannie's financial struggles, he said the adjusted pricing, tightened credit standards and improved capital reserves will "ensure that we're in good shape to weather the correction" and help stabilize the market. "During the housing run-up, we kept our exposure to subprime and exotica limited," he said. "But no one is immune to the rise in foreclosures and decline in mortgage values, and we're taking our lumps."

Despite the GSEs' difficulties, Fitch's Arscott remains confident in their ability to help out the Treasury or Federal Reserve if called upon. "Fannie and Freddie are in their back pocket, so to speak, and if things get materially worse and the market's dislocation really has an impact on the broader economy, I think they may tap Freddie and Fannie on their shoulder and ask them to do certain things," he said.

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

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