Last week Senate Banking Committee Chairman Richard Shelby, (R., Ala.), announced that his committee will meet this Thursday to mark up the GSE regulatory reform bill. Shelby did not specify what the legislation would require in terms of Freddie Mac and Fannie Mae portfolio reduction. The Alabama Republican's statements came after Federal Reserve Chairman Alan Greenspan said that both GSEs would be better off investing in U.S. Treasurys rather than mortgage-backeds, which, he said, the agencies should not even be allowed to purchase.

These pronouncements come amidst indications that the Shelby bill contains a provision requiring the GSE regulator to limit GSE portfolio holdings to those that support the GSE mission, a provision that is not expected to gain bipartisan support, derailing the bill's passing. But bill or no bill, the GSEs are expected by analysts to reduce their portfolios anyhow.

Newly hired Banc of America Securities equity analyst Robert Lacoursiere - who recommended a Sell rating for Fannie Mae on BofA's first-ever report on the GSE -noted that Fannie now holds an unsustainable $731 billion "non-mission" supportive portfolio. BofA predicts that both Fannie and Freddie will be reducing their portfolios at a 3.5% quarterly rate, and will be decreasing their combined portfolios to $1.05 trillion by the end of next year from $1.52 at the end of the first quarter. BofA added that despite Fannie's excess capital generation - which could return value to investors - Fannie could instead use this in other ways if there are other attractive growth options allowed under a new regulator or if the "non-mission supportive" runoff is faster than anticipated.

Equity analyst Kenneth Posner from Morgan Stanley, on the other hand, expects the new regulatory regime to be "less stringent than market fears," predicting that a new regulator would likely increase capital standards for the agencies' retained portfolios to 4% to 5% from 2.5%. Posner said the increase could restrict Fannie and Freddie risk taking as well as significantly reduce the GSEs' competitive advantage, leaving them with less opportunity to grow. For instance, Posner said that the regulator could require higher levels of purchase options as a way to reduce dynamic hedging - another issue that was raised by Chairman Greenspan - or minimize the use of short-term debt.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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