Federal regulators have made an official determination that Fannie Mae and Freddie Mac are undercapitalized, but have suspended rules that would have required the companies to raise additional money.

The Federal Housing Finance Agency, which placed Fannie and Freddie into conservatorship on Sept. 7, said today that Fannie and Freddie have effectively been undercapitalized since June 30.

But the Treasury Department’s backstop of the companies — a line of credit and purchase of senior preferred stock — ensures that "for the very long term both entities will have positive net worth," and will be allowed to continue purchasing and guaranteeing mortgages, FHFA said.

Before being placed into conservatorship, Fannie calculated its core capital of $47 billion represented a $9.4 billion surplus above that required by regulators. Freddie Mac said its $37.1 billion in core capital exceeded regulatory requirements by $2.7 billion.

The continued market downturn during late July and August "raised significant questions about the sufficiency of capital," FHFA said today. Regulators said accelerating safety and soundness weaknesses, especially with regard to credit risk, earnings outlook and capitalization, supported their decision to classify the companies as undercapitalized.

Suspending rules that would have required Fannie and Freddie to raise additional capital — something the companies were having difficulty doing before the government essentially took them over last month — allows Fannie and Freddie to continue providing liquidity to mortgage markets in the face of mounting losses.

When they took Fannie and Freddie over in September, regulators said the companies would be permitted to expand their direct investments in mortgage-backed securities from $1.5 trillion to $1.7 trillion over the next year (see story). With the government standing behind the companies, investors have also continued to see mortgage-backed securities guaranteed by Fannie and Freddie as safe investments, helping keep mortgage rates affordable.

Rates on 30-year fixed-rate mortgages dipped below 6 percent after the companies were taken over. While uncertainty in credit markets in recent weeks has sent mortgage rates back up again, loans eligible for purchase or guarantee by Fannie and Freddie this week again dipped below 6 percent (see story).

As long as Fannie and Freddie are in conservatorship, "FHFA will continue to closely monitor capital levels," regulators said. But the capital limits formerly mandated by Congress — and even stricter requirements put in place by regulators after accounting and management scandals rocked the companies in 2003 and 2004 — "will not be binding during the conservatorship."

Fannie and Freddie will continue to submit capital reports to FHFA during the conservatorship, and minimum capital requirements, core capital and net worth data will be available in the companies’ quarterly 10-Q filings and as well as on FHFA’s Web site. But FHFA said it does not intend to publish critical capital, risk-based capital or subordinated debt levels during the conservatorship.

FHFA said it plans use its authority under the Housing and Economic Recovery Act to revise Fannie and Freddie’s minimum capital and risk-based capital requirements. The new requirements would presumably be applied if and when the companies emerge from conservatorship.


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