Fannie Mae'scredit losses will exceed the company's expectations, continuing to put pressure on its capital levels and earnings, an analyst at Friedman Billings Ramsey said.
The largest U.S. home-funding company would need to raise additional capital of $5 billion to $10 billion to strengthen its balance sheet for future credit losses and continue to supply liquidity to the mortgage market, analyst Paul Miller said in a note.
Credit losses will not peak until late 2009/early 2010, and this should result in elevated provisioning over the next three to four quarters, possibly pressuring the company's capital cushion, he said.
"We believe the GSEs (government-sponsored enterprises) will continue to have trouble with both credit losses and capital levels, and we recommend that investors remain cautious on the names over the next few quarters," the analyst said.
Miller cut his price target on the shares of Fannie Mae to $6 from $11 to reflect continued pressure on capital from credit losses. He maintained his "underperform" rating in the stock.
With credit-related expenses of $7 billion to $8 billion over the next two quarters, the company's capital cushion, which currently stands at $9.4 billion, could be materially cut to the point that it may have to raise additional capital, Miller said.
"The big question for investors is, will elevated provision eliminate Fannie Mae's capital cushion and result in a capital raise over the next few quarters?"
Although the company's revenue rose in the second quarter, and should continue to be strong over the next few quarters, it will not be enough to offset future credit costs, he said.
"We believe house prices continue to decline, and loss severity is increasing in our opinion," Miller said.
The company will make it through the current housing crisis, but the shareholders are exposed to losses as rising credit cost will continue to pressure valuation of the stock, he said.
On Friday, Fannie Mae posted its fourth straight quarterly loss as home-loan defaults increased, and said it "may, from time to time, raise capital opportunistically" after raising more than $7 billion in added capital in the second quarter.
Shares of the company closed at $9.05 Friday on the New York Stock exchange.