Market estimates of cumulative losses of $400 billion at Fannie Mae and Freddie Mac are "overly pessimistic," declared analysts at Keefe, Bruyette & Woods (KBW).

KBW estimates total losses of $200 billion, using what it says are conservative assumptions. The analysts said this includes their belief that the Home Affordable Modification Program will not be very effective.

In its modeling, KBW takes into account the idea that even if all the permanent modifications should redefault, the delinquency rates should remain well below the expected delinquency rate it uses for both companies. KBW also uses a 60% loss severity rate; so far the companies have been experiencing a sub-40% loss severity rate.

While both companies reported third quarter losses, credit costs have "fallen meaningfully." Furthermore, both should be adequately reserved for their legacy mortgage portfolio by the end of the year.

But even after they are done reserving, the pair will still post losses because they will have to pay the federal government between $15 billion and $20 billion each year as interest on their debt.
As for the future of the two, "We believe the current structure of the GSEs will eventually be wound down, wiping out current shareholders but we expect the government to find a home for the core guarantee business," the KBW report said.

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