26
Aug
Fannie, Freddie, and the Credit Crisis
John Mauldin
Aug 25, 2008
Let’s turn to Fannie (FNM) and Freddie (FRE). There must be some people who think their shareholders won’t lose everything, as their shares still actually trade. This just goes to show that you can fool some of the people some of the time. And as we’ll see, some of those people are very serious institutions.
It’s almost a foregone conclusion that the US Treasury will have to step in and essentially nationalize the 2 government-sponsored enterprises. The estimated losses in these 2 firms are far beyond what they could raise in a traditional market. And the longer the government waits, the worse the situation is likely to get.
Moody’s downgraded the preferred stock in these firms to almost junk levels because of the increased likelihood of “direct support” from the US Treasury. Depending on the nature of the support, this could wipe out holders of both common and preferred.
The preferred shares have already lost half their value since June 30 on speculation that an intervention would mean a stop in dividend payments (highly likely) - and that issuance of new preferred would take preference over current preferred.
Interestingly, this would put more pressure on the banking system, as many banks hold GSEs’ preferred shares as assets, choosing to get a little extra return over more conservative traditional assets.
Of course, Fannie and Freddie’s preferred were considered safe just a few months ago, with the best ratings from Moody’s. Bloomberg notes:
“Regional banks, including Midwest Bank Holdings (MBHI), Sovereign (SOV) and Frontier Financial (FTBK), may have the most to lose… Midwest has $67.5 million, or as much as 23% of its risk-weighted assets, in the preferred stock, while Sovereign owns about $623 million and Frontier about $5 million.”
It’s doubtful that banks holding these assets have written them down - but a downgrade will almost certainly force them to do so in the near future. For the record, Fannie Mae has 17 classes of preferred stock, with more than 600 million shares outstanding. Freddie Mac has 24 classes of preferred stock, with about 460 million shares outstanding. The existing shares are trading worse than junk bonds, paying 17% to 19%.
And it may be a total write-off. It’s hard to imagine how Treasury Secretary Paulson, or a new Treasury Secretary next year, could put US taxpayers’ money in these companies at risk without wiping out the current common and preferred shareholders.
The justified outrage would be huge.
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