Interest Rate Roundup

Friday, August 22, 2008

Fannie, Freddie preferreds an issue for some banks

One of the interesting dynamics in this whole Fannie Mae, Freddie Mac situation is the GSEs' preferred shares. Many institutions hold positions in Fannie and Freddie preferred paper, and there is a general expectation that any government bailout will prove detrimental to those securities. If the Treasury were to inject money into the GSEs, it might do so by purchasing a new class of preferreds that is senior to the existing securities, for instance. That, in turn, would hurt the value of the existing preferred shares, which are on the books of bank all over the country.

Sovereign Bancorp, for instance, bought into Fannie and Freddie paper for about $900 million, according to a recent Bloomberg report quoting CFO Kirk Walters. The value of those stakes had declined to $623 million as of the end of June. A separate Bloomberg story today talks about other institutions that own Fannie and Freddie preferreds. Here's an excerpt:

"Midwest Bank Holdings Inc. Chief Investment Officer Don Wiest is wagering U.S. Treasury Secretary Henry Paulson will rescue him from a failing $67 million stake in Fannie Mae and Freddie Mac.

"Melrose Park, Illinois-based Midwest and banks from Philadelphia-based Sovereign Bancorp to Frontier Financial Corp. in Everett, Washington, own preferred shares in the beleaguered mortgage-finance companies that have lost more than half their $35 billion value since June 30. Concern that Paulson may step in with a rescue plan that would wipe them out along with common stock investors has sent the securities tumbling.

"I guess we are betting on Paulson,'' Wiest, 54, said. ``We have to believe that his plan carries the day somehow.''

"Midwest, an owner of banks in Illinois, has $67.5 million, or as much as 23 percent of its risk-weighted assets tied up in Washington-based Fannie and Freddie of McLean, Virginia.

"Small, regional banks may have the most to lose from the stumbles in Fannie and Freddie, and Paulson may risk bank failures unless he protects preferred stockholders, said Ira Jersey, an interest-rate strategist at Credit Suisse Group AG in New York. The impact on the preferred holders "may be an important driver'' in Paulson's decisions, Jersey said.

"Any wipeout of the preferreds could have implications for the capital of the greater financial system and these regional banks that might have reasonably precarious capital situations,''Jersey said. "You don't want to make that worse if you're the government.''

Speaking of this issue, Moody's just came out with a note this morning slashing its ratings on Fannie and Freddie preferreds by five steps to Baa3 from A1. That is the lowest possible investment grade. Moody's had this to say about its move:

"The downgrade and continued review for further downgrade of the preferred stock ratings reflects a greater risk of dividend omission on the preferred stock. This greater risk stems from two issues. First, both Fannie Mae's and Freddie Mac's mortgage portfolio performance is worse and more volatile than Moody's expected. This could lead to the firms breaching their capital requirements that govern their ability to pay a preferred dividend. Second, there is uncertainty with regard to how these preferred securities would be treated should the US Treasury provide Fannie Mae or Freddie Mac with support. Should a capital injection result in the subordination of the existing preferred stock, or should it result in any missed preferred dividends, then the preferred stock rating would be lowered further."


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