Tuesday, August 19, 2008

US Economic Crisis Bulletin: Fresh Concerns as Fannie Mae and Freddie Mac Plunge; Lehman Examines Neuberger Berman Sell-off

Fresh fears as Fannie and Freddie plunge

By Michael Mackenzie, Saskia Scholtes and Nicole Bullock in New York and Krishna Guhain Washington
Financial Times
August 19 2008 02:17

Fears about the financial system grew on Monday as money market liquidity tightened and sharp falls in the share prices of mortgage financiers Fannie Mae and Freddie Mac led the US stock market lower.

Fannie’s and Freddie’s shares lost 22 per cent and 25 per cent, respectively, after an article in Barron’s suggested that the US government was considering recapitalising the companies on terms that would all but wipe out existing shareholders.

The concerns about Fannie and Freddie also spread to their debt, which fell in price. This threatened to push interest rates on mortgages backed by the two firms higher and put further pressure on the battered housing market.

The average rate on so-called “conforming” 30-year fixed rate mortgages has already risen by about 60 basis points since the start of June to 6.69 per cent.

Anxieties were also reflected in the money markets, where the three-month London interbank offered rate – the key rate at which banks lend to each other in US dollars – rose to a two-month high.

“There is still stress in the system,” said George Goncalves at Morgan Stanley. “Libor is creeping up and banks are still restructuring their balance sheets.”

A Treasury spokeswoman said the report in Barron’s was “speculative” and the US government still had no intention of using its newly acquired powers to invest in the two firms.

However, selling spread to other financial institutions with direct exposure to Fannie and Freddie, and to the housing market in general, highlighting the systemic importance of the two companies and the danger that their troubles could cause renewed financial contagion.

Financial shares also fell, helping to push the S&P 500 down 1.5 per cent.

The price of insurance against default on Fannie and Freddie subordinated debt hit record levels in the credit default swaps market, according to data from Markit. Risk spreads on their senior debt – which most analysts presume would be fully honoured by the government in any rescue – widened to levels last seen in the immediate run-up to the Treasury’s July 13 rescue plan, Credit Suisse said.

Under that plan, the US government secured from Congress blanket authority to invest in Fannie and Freddie, but held back from actually doing so.

Three-month Libor reached 2.81 per cent, a level not seen since mid-June, in spite of the decline in expectations of a Federal Reserve interest rate rise since then.

“A year’s worth of tightening credit is only now being felt,” said Tobias Levkovich, chief US equity strategist at Citigroup.

Swaps forecasting the difference between three-month Libor and the Fed funds rate for the end of the year rose to 93bp, up from 79bp less than a week ago.

Further evidence emerged last week that banks were scrambling to raise short-term funds. Concerns about banks’ health have made it harder and more expensive for them to access funds.

Reflecting this, demand for funds from the Fed’s Term Auction Facility, introduced as a prop to the banking system, has risen. Similarly, European banks have flocked to the European Central Bank for dollar funds.

Mr Goncalves said a sudden surge in Libor could lead to an expansion of the $150bn TAF.

Copyright The Financial Times Limited 2008

Freddie Mac plans $3bn debt issue

By Nicole Bullock in New York
Financial Times
August 18 2008 22:59

Freddie Mac was on Monday marketing a $3bn benchmark five-year debt issue even as renewed concerns about the future of the US government-sponsored entities (GSEs) sent ripples through the financial markets.

Shares of Fannie Mae and Freddie Mac hit their lowest levels in nearly two decades on fears of a federal bail-out that would eliminate the common stock, as well as significantly reduce the value of preferred shares and subordinated debt.

This scenario is not a new one, but a weekend story in Barron’s magazine rekindled investor worries over the relative value of the various parts of the capital structure should the federal government nationalise the GSEs.

“It’s unclear where the government is going to inject capital, if they do,” said Ira Jersey, US interest rate strategist at Credit Suisse. “Because of that lack of clarity, it’s hard to make an informed investment decision.”

Fannie fell 22.3 per cent to $6.15 and Freddie lost 25 per cent to $4.39. In the credit markets, the cost of protecting against default on the GSEs’ subordinated debt surged to record levels, according to Markit, a data provider. Credit default protection on the senior debt was largely unchanged.

Trading in the senior and subordinated debt diverged this summer on the belief the US Treasury’s plan to support the agencies would provide senior debt with a government guarantee.

However, the prospect of a new debt issue this week from Freddie Mac pushed risk premiums on existing bonds higher relative to US Treasury debt.

The next test of investor sentiment towards the GSEs will come on Tuesday when Freddie is expected to price $3bn of five-year reference notes. Its existing five-year note was quoted on Monday at a spread to Treasuries of about 105 basis points.

Fannie and Freddie have struggled to absorb the losses from the housing slump. Earlier this month both slashed their dividends. Fannie and Freddie Mac own or guarantee about $5,300bn in US mortgages.

Copyright The Financial Times Limited 2008

Lehman examines Neuberger Berman sell-off

By Henny Sender in New York
August 19 2008 01:48

Lehman Brothers is holding exploratory talks with a variety of private-equity and strategic bidders about selling all or part of its asset management arm, Neuberger Berman, according to people familiar with the matter.

Lehman “has to fill the void and the way to do that is establish what their options are”, says a senior executive at one private equity firm who has been approached and has received documents with information about the business.

The business, which Lehman bought in 2003 for $2.6bn, is today worth as much as $10bn, analysts say.

A spokeswoman for Lehman declined to comment.

Lehman is trying to find the least painful way to fill the hole on its balance sheet at a time when it is hard to raise equity capital – a problem similar to that faced by Merrill Lynch before it sold off its stake in Bloomberg.

Lehman is trying to choose between selling troubled portfolios, such as its commercial real estate assets, or selling crown jewels such as the asset management business. Lehman lacks non-core assets that are easy to hive off, such as Merrill’s stake in Bloomberg.

One challenge in any Neuberger sale would be to keep its portfolio managers from rebelling. At the time of Lehman’s original purchase, 30 top fund managers at Neuberger received share packages with long holding periods. Since that time, Lehman’s share price has collapsed. To keep critical staff from leaving, any buyer would be likely to have to offer generous packages.

“Can you come up with enough economics for employees and still offer Lehman enough to convince them to sell?” asks the private equity executive who has received documents with information about Neuberger.

Private equity firms are keen to expand their assets under management at a time when many are determined to follow Blackstone into the public market.

Similarly, there are money management firms who are not strong in the so-called long-only equity management business, which is considered Neuberger’s core strength.

Dick Fuld, Lehman’s chief executive, is understood to have explored several options. Talks with strategic investors in Asia regarding a stake in the firm itself went nowhere – at least up to now, according to people familiar with the matter.

Some hedge funds (which Lehman spent heavily on to acquire minority stakes in) loyally came forward when Lehman raised capital this spring and were rewarded with heavy losses. Now they are considering buying back those stakes – at a deep discount. Meanwhile, their own poor performance is a further drag on Lehman.

Copyright The Financial Times Limited 2008

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