Standard & Poor’s lowered its ratings on the subordinated debt of Fannie Mae and Freddie Mac yesterday.
Not by a small amount either: preferred stock and sub debt moved three notches, from AA- to A-.
Senior debt, though, remained unchanged. Still triple A.
That, of course, reflects not the underlying modelled rating deserved, but rather, a post hoc rating assigned on the basis of one particular assumption: that no matter how parlous the state of FNM, FRE’s finances, the US government will support the senior debt.
While the possibility of government support/intervention is succour for senior noteholders, pace Monday’s downgrade, if anything, the opposite is the case for owners of subordinated paper.
New government legislation, for example, puts preferred stock holders in particular, at risk. Notes S&P on Freddie:
The regulatory authority now has receivership powers that would place the nonsenior creditors of Freddie Mac at a greater risk of nonpayment, especially the dividend payments on preferred stock.
…
If Treasury actually provides equity support to Freddie Mac as authorized under this backstop plan, we believe that all subordinated creditors of Freddie Mac could be at an even greater risk of default.
The more immediate issue, though, is the fact that Freddie and Fannie are both coming close to breaching their regulatory capital requirement levels.
Freddie’s cushion over the 20 per cent surplus capital level required by the OFHEO has declined to just $2.7bn – a level which, according to S&P, “the firm will be more challenged to maintain… in the near term.”
Fannie, meanwhile, is expected to “keep capital ratios above regulatory minimum requirements” by the rating agency, but only on the back of further capital raising efforts.
Indeed, capital raising is the name of the game. As the WSJ’s MarketBeat blog reports, FBR capital markets analyst Paul J. Miller, anticipates $5bn – $10bn in addition capital for FNM alone.
Related links
Fannie Mae loses $2.3bn and cuts dividend - FT
Freddie deepens housing gloom with $820m loss and dividend cut – FT
FHFA From OFHEO Over GSE With HUD And FHFB – Matrix