Credit markets question value of GSEs' top ratings

NEW YORK (Reuters) - The implicit government support of Fannie Mae (FNM.N: Quote, Profile, Research, Stock Buzz) and Freddie Mac (FRE.N: Quote, Profile, Research, Stock Buzz) that is critical to companies holding their top debt ratings remains intact, but that hasn't stopped credit markets reacting as though the ratings don't reflect their risk.

Fannie and Freddie's debt protection costs have surged, while their stock prices have plunged, on concerns over their ability to raise enough capital to cover losses from residential mortgages they guarantee.

"We continue to see a disconnect between market fears of unsustainable losses and the regulators' reiterating that both agencies are liquid and solvent," said Ricardo Kleinbaum, analyst at BNP Paribas in New York.

The cost to insure the government-sponsored entities' senior, "AAA"-rated debt has jumped to around 76 basis points, or $76,000 per year for five years to insure $10 million in debt, from the 40 basis point area in May, according to Markit Intraday.

Key to the senior debt being rated "AAA" is the implicit government support of the two big mortgage finance companies.

As of Wednesday night, however, their credit default swaps implied that traders consider the companies to be "A3," six steps below their actual ratings, according to the credit strategy group at Moody's Investors Service.

"U.S. policymakers are in a tight spot here because they want to support Fannie Mae and Freddie Mac but can't appear to be seen as bailing out shareholders," Kleinbaum said.

"And from a regulatory accounting perspective, the GSEs are now adequately capitalized," he added. "So the government's focus right now is managing global investor confidence with the only plan on the table remaining issuance of additional equity."

Fannie Mae and Freddie Mac are expected to need billions of dollars in capital to offset losses and fund the expansion of their mortgage portfolios. The two found strong demand as they raised some $20 billion since late last year, but the falling share prices since raises doubts about new investor support.