The possible downgrade of Fannie’s and Freddie’s subordinated debt involves only a small amount of the GSEs’ total debt, but the symbolism is more important than the dollar amounts. It validates some of the critics’ worries about Fannie and Freddie but also signals the possibility that not only shareowners could be wiped out, but even preferred stockholders and sub debt owners are exposed even with the government rescue effort. Put more simply, this move the view that the firms are undercapitalized.
From Bloomberg:
Standard & Poor’s may downgrade the subordinated bonds of Fannie Mae and Freddie Mac, surprising investors who had anticipated the securities would be supported by any Treasury rescue plan.The potential cut would affect $19.2 billion of AA- rated subordinated debt at Fannie Mae and Freddie Mac, according to data compiled by Bloomberg. The cost to protect the bonds from default rose for the first time in three days. S&P said it may also cut $26 billion of preferred stock, pushing down the securities in New York trading. The AAA ratings on the companies’ senior debt were affirmed with a stable outlook.
New legislation authorizing a backstop of the mortgage- finance companies leaves it up to the Treasury Secretary to decide whether to honor preferred dividend payments or to repay subordinated bondholders before the government, S&P analyst Victoria Wagner said in a telephone interview. That “ambiguity” casts a cloud over the ratings, she said. Once analysts have fully analyzed the final legislation, the ratings may be cut one or two levels, she said.
“We had factored in some federal support for these securities, but now I think the financial risks are now outweighing support and have to be reflected in the rating,” Wagner said….
The plunge in the stocks is “adding to the already-stressed business cycle” and may make it difficult for the companies to raise capital, Wagner said.
“We feel that given the changing market dynamics and the changing legislation landscape, that that heightened risk should be more of a factor in our current,” Wagner said.
Investors had anticipated any government rescue would come in the form of equity, which would rank behind subordinated debt for repayment, said Jamie Jackson, a portfolio manager at Minneapolis-based RiverSource Investments, which manages $93 billion of fixed-income assets.
The potential downgrade of the preferred stock isn’t as surprising, Jackson said.
“The fact that they lumped the sub debt in there seems questionable,” Jackson said. “If we are talking about equity capital being contributed by the government, by any measure that we can come up with, that should protect the subordinated debt.”
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Woo hoo… it seems like we are playing Fannie and Freddie Limited Edition Whack-a-Mole.