S&P May Lower Rating on Fannie, Freddie Subordinated Debt

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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  1. Anonymous

    Woo hoo… it seems like we are playing Fannie and Freddie Limited Edition Whack-a-Mole.

  2. wintermute

    Yves, The problem is moving on even from FNM/FRE.
    The emperor (Tier 3 assets) has been called naked! Not by a wide-eyed boy – but by a foreign bank. National Australia Bank has made loss provisions for 90% of its US mortgage CDOs.


    That begs the question of the status of the tens of billions of similar holdings in Citibank, Merrill Lynch and even Goldman Sachs. How long can any of the big banks pretend Tier 3 assests will “come right”.

  3. pepster


    I would also like to know your thoughts on what wintermute posted, namely NAB’s writedown (or was it write off?) of 90% of the value of its AAA-rated US mortgages. Needless to say, this looks like it might be a really big deal.

  4. Anonymous

    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.”

    Is Jackson’s statement not a clear admission that (he and no doubt many others, believe) every single cent of taxpayer contribution (without limit) should be sacrificed to save any loss for the holders of debt.

    “by any measure” the Creditors of the USA will eventually fill in the numbers on Blank Cheque Benny’s promise.

    Yes, the Creditors know it will hurt them and can adapt to that hurt. But they also know that the mirage cannot continue or they will end up worse off than the US.

  5. Dave Raithel

    I’ll play dumb, it ain’t too hard to do. I want to know: Is anybody anywhere really keeping track of the arithmetic? My point here is not just referenced to this article, but to all of them that I’ve been finding here and other places about the billions and billions (and I don’t mean stars)written off and downgraded and declared as losses at this bank that bank, everybody just pick a bank. So to start at the very beginning: Does the sum total of all losses attributable to the current list of defaulted properties equal what’s being written off by who claims to hold the right to get paid? If not, then what’s the source of other losses in all the fancy paper – credit cards? car loans? student loans? equity loans? How would I know if Larry isn’t in hock to Curley so Larry could pay Moe, and Moe owes Curley as much…? Bet I get some kind of mark to market mumbles. This is my trip: All the paper has to point, at some point, to aspects of reality that ain’t paper. Between kicking people out of their homes, and putting everybody at Fanny and Freddy on a GS pay schedule, what’s really to choose?

  6. Stuart

    Some comments on this from Jim Sinclair.

    “A serious event occurred today. This event was the very public international recognition of more off balance sheet so called “assets” revealed as having little, if any, value.

    This event is arguably the most serious financial upset ever. If you have not protected yourself, it is getting very late – maybe too late.

    Your best hope is that this event is so complex that the herd of self anointed experts has no clue what that vehicle is, how large it is and therefore the profound meaning it has.

    The meaning of this is not only are Freddie and Fannie’s troubles much costlier than realized, but now there is an entirely new definition of market-less financial entities with off balance sheet assets that undermine primarily the US and now international banking systems. Conduit mortgage OTC derivatives will have to be marked down now that the sun is shining on them.

    The U.S. mortgage industry transformed itself in a way that has opened dangerous SIV sub prime real estate conduits to global capital markets.

    A conduit loan is priced by swaps and swap spreads, thereby becoming a package of various OTC derivatives generally derived from a formula that would make Einstein look like a kindergarten mathematician.

    By turning mortgages into securities, lenders created vast distances between homeowners and their mortgage holders, who can be anywhere in the world such as Australia.

    US banks have written down $450 billion in bad housing loans. The revelation from NAB means that they will now certainly need to take provisions to $1,000 billion. Write-downs of $1,300 billion and perhaps even more are in the cards.”

    Those with skin in the game on this side of the ocean will likely try and do everything possible to sweep the NAB situation under the carpet and forget about it as if it doesn’t exist. Watch for it.

  7. Anonymous

    Enormously surprising to see someone at the rating agencies with cojones…do you think Hanky Panky will order Rob't Rubin to phone his contacts at S&P to stave this off, a la Enron?

    Whither Phil Gramm, and Franklin Raines…now that the proverbial merde is hitting the fan?

  8. Mark M

    As we watch the various players maneuver around in the current financial quagmire, a pop quiz might be in order:

    Along with (Democrats) Alan Cranston, John Glenn, Donald Riegel and Dennis DeConcini, which Republican candidate for President was a member of the infamous Keating Five?

    Correct!! … John McCain

    In the current play, with its gray and winding undercurrents, we also have a mixed bag of Democrats and Republicans. Greed has no political alignment, it would appear, so let none of us be casting partisan stones.

    That being said, do we really want one of Keating Five leading the country through the current financial crisis? I would ask the same question if McCain were a Democrat – like the other four.

    We need honesty, ethics and openness in our next leader. Tough times are heading our way, and cleaning the cesspool is going to be a big part of the job.

    Again, I’m not casting partisan stones. Rather, I’m just emphasizing that “It’s the economy, stupid” is truer now than at any time since the Great Depression.

    Something to keep in mind as you head into the voting booth in November, however you decide to cast your vote.

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