August 25, 2008 / 2:41 PM / in 10 years

UPDATE 1-Nationalization of GSEs still unlikely: Citigroup

(Changes source; adds analyst comments, background)

Aug 25 (Reuters) - A nationalization of Fannie Mae FNM.N and Freddie Mac FRE.N was still unlikely, but the current financial challenges facing the two U.S. housing giants as well as their significance to the economy may eventually require action, said an analyst at Citigroup.

Last week, investors turned increasingly fearful that the federal government will be forced to bail out the two government-sponsored enterprises (GSEs), potentially wiping out the two firms’ equity value.

Analyst Bradley Ball, however, said the GSEs were not entirely without options, and added that they should continue to be most effective in their current shareholder-owned form.

The options that Ball spelt out for the GSEs include — policymakers publicly reassert benefits of the backstop plan that became law last month; their regulator ease the arbitrary capital surplus requirement further; GSEs free up capital by selling mortgage-backed securities to Treasury and/or allowing portfolio assets to run down over time.

Fourth option would be for all parties to “wait-it-out” until market conditions calm, given sufficient capital through at least year-end, Ball added.

“We continue to believe the GSEs are best equipped to provide needed mortgage market stability,” Ball said. The GSEs together own or guarantee about half of the $12 trillion U.S. mortgage market.

“However, recent market pressures make it more difficult for them to execute their mission, potentially forcing management and policymakers to take extraordinary actions,” the analyst added.

Although such actions are “uncertain,” Ball expects shareholders’ interest to be preserved. He cut his price target on Fannie shares to $9 from $21, and on Freddie to $6 from $16. He rates both stocks “buy.”

Last week, a major credit rating agency cut the preferred share rating on the GSEs amid mounting concern about their ability to access capital. [nN22590161]

Treasury Secretary Henry Paulson last month outlined a series of backstop measures that could be used to support Fannie and Freddie, including a fresh injection of capital from the government.

Speculation has mounted in financial markets that Treasury eventually would be forced to add capital, causing investors to question how such a move could affect the corporate structures. Shares of Fannie were up 1 percent at $5.05 in morning trade on the New York Stock Exchange, while those of Freddie were trading up more than 8 percent at $3.03. (Reporting by Tenzin Pema in Bangalore; Editing by Himani Sarkar)

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