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The Day That Alt-A Mortgages Died

Housing-Market / US Housing Aug 08, 2008 - 02:17 PM GMT

By: Mike_Shedlock

Housing-Market Best Financial Markets Analysis ArticleBloomberg is reporting Fannie Mae, Battling Losses, to End Alt-A Mortgages .
Fannie Mae, the largest U.S. mortgage- finance company, will stop buying or guaranteeing Alt-A home loans, such as those that require little or no documentation of borrower incomes or assets, by yearend.

The company announced the changes when reporting its fourth straight quarterly loss today. The second-quarter net loss of $2.3 billion, or $2.54 a share, included $5.3 billion in credit- related expenses.


"Over 60 percent of our losses have come from a small number of products, but especially Alt-A loans," or ones considered between prime and subprime in terms of expected defaults, the Washington-based company said in a statement.

McLean, Virginia-based Freddie Mac, which reported an $821 million quarterly loss two days ago, said that Alt-A mortgages were the biggest reason for a surge in its foreclosure losses. The delinquency rate for the $190 billion of the loans owned by Freddie Mac or underlying the bonds the company guarantees jumped to 3.7 percent on June 30, from 1.8 percent on Dec. 31.

Fannie Mae Posts Fourth Straight Loss, Cuts Dividend

Freddie Mac missed earnings expectations by a mile and today Fannie Mae reported similar news: Fannie Mae Posts Fourth Straight Loss, Cuts Dividend .

Fannie Mae, the largest U.S. mortgage- finance company, cut its dividend 86 percent after posting a loss that was more than three times analysts' estimates and said the worst housing slump since the Great Depression is deepening.

Fannie, which owns or insures about 25 percent of all U.S. mortgages, said credit losses rose 66 percent to $5.3 billion as delinquencies rose. Chief Executive Officer Daniel Mudd forecast a "significant'' increase in reserves for the rest of the year as the housing market deteriorates. Fannie's results, combined with a loss by Freddie Mac that was also wider than analysts anticipated, may boost the need for Treasury Secretary Henry Paulson's bailout plan announced last month.

The results "increase the probability of the government stepping in," said Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia, who has an "underperform" rating on both companies. "Neither of these companies have properly provisioned for what we're heading into. This thing is going to get worse and last longer and deeper than they originally thought."

The Big Bailout Is Coming

I spoke about Freddie Mac's preposterous claims on expected losses yesterday in Fannie, Freddie Reality Check: The Big Bailout Is Coming .

Chris Whalen On GSEs



"Recognize the economic realities. The GSE's cannot function without the backing of the Treasury. They can't borrow at rates low enough to make their business model work unless the full faith and credit is there. It's Done. It's just a question of when we recognize reality. $80 billion dollars is not enough to back Fannie and Freddie. It should have been $800 billion. This whole thing is like a platypus.... Fannie Mae is nothing but a big fixed income hedge fund, the biggest in the world."

While I agree with most of Whalen's comments about what is happening, I certainly disagree that a bailout of the GSEs is the right solution. Right or wrong, the big bailout is coming, but it will not be $800 billion. The statement above is about capitalization and funding, not about expected losses.

Fannie Mae Conference Call

Calculated Risk posted some interesting comments from Fannie Mae's conference call in Fannie Mae: Q2 Ended in June, but July was Worse . Here are a few of them:

July was a tough month for our credit performance. We experienced higher defaults and higher loan loss severities in the markets that were experiencing the steepest home price declines. And that gave us higher charge-offs than we had experienced in any month in the second quarter, and higher than we had expected.

Home prices have cratered in certain markets since the peak -- Cape Coral, Florida, down 50%; Las Vegas, down 35%; northern Virginia, down 30%; and in California, Modesto, and Stockton, down 50%; Riverside, down 40%. The list goes on. Alt-A foreclosures have doubled in southern California. Our average serious delinquency rate in Florida increased in June to over 3% -- four times the average on our total book of business last year. Almost 2% of the loans in our Florida book are now referred to foreclosure. So, the housing market has returned to earth fast and hard.

Fannie Mae Press Release

The Fannie Mae Press Release was interesting.

“Volatility and disruptions in the capital markets became even more pronounced in July. In addition, credit performance has continued to deteriorate and, based on our experience in July, we anticipate further increases in our combined loss reserves. Given this volatility and the build-up of our reserve, as well as the uncertainties inherent in the U.S. economy and the housing market, we are taking a series of additional actions that reflect our ongoing focus on conserving and enhancing our capital, as well as managing our credit risk through the balance of this cycle.”

While we continue to expect home price declines in 2008 to be within our estimated 7 to 9 percent range, and peak-to-trough home price declines to be within our estimated 15 to 19 percent range, we see the trend moving toward the high end of those ranges, driven in particular by higher home price declines in certain regions. We are increasing our forecast for our credit loss ratio for the full-year to 23 to 26 basis points, as compared to our previous guidance of 13 to 17 basis points. We continue to anticipate that our credit loss ratio will increase further in 2009 compared with 2008. We also expect significant additions to our combined loss reserves through the remainder of 2008. Finally, while we expect that 2008 will be our peak year for credit-related expenses, the total amount of credit-related expenses will be significant in 2009.

All of this makes one wonder what the heck Freddie Mac CEO, Richard Syron was smoking yesterday when stated Freddie would postpone raising capital, something that would make sense only if conditions were expected to get better, not worse.

Fannie Mae's decision to cancel Alt-A loans tells the story. Expect losses on Alt-A to continue to horrendous, so much so that Fannie had to throw in the towel on Alt-A loans.

Lyrics American Pie

A long long time ago
I can still remember how that housing used to make me smile
And I knew if I had my chance
That I could make those people dance
And maybe they'd be happy for a while
But February made me shiver
With every paper I'd deliver
Bad news on the doorstep
I couldn't take one more step
I can't remember if I cried
When I read about the foreclosed brides
But something touched me deep inside
The day that Alt-A died

By Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com

Click Here To Scroll Thru My Recent Post List

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management . Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

Visit Sitka Pacific's Account Management Page to learn more about wealth management and capital preservation strategies of Sitka Pacific.

I do weekly podcasts every Thursday on HoweStreet and a brief 7 minute segment on Saturday on CKNW AM 980 in Vancouver.

When not writing about stocks or the economy I spends a great deal of time on photography and in the garden. I have over 80 magazine and book cover credits. Some of my Wisconsin and gardening images can be seen at MichaelShedlock.com .

© 2008 Mike Shedlock, All Rights Reserved

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