Credit markets question value of GSEs' top ratings
NEW YORK (Reuters) - The implicit government support of Fannie Mae (FNM.N) and Freddie Mac (FRE.N) 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.
"The GSE's are critical to mortgage market stability, if the market doesn't believe that they're stable then it can't accept them as providers of liquidity and guarantors for the mortgage-backed market regardless of the AAA ratings," BNP's Kleinbaum said.
LEGISLATION
Jitters about whether Fannie and Freddie could become insolvent have come to the fore at the same time as legislation designed to help thousands of distressed homeowners avoid foreclosure works its way through government.
Liquidity provided by Fannie Mae and Freddie Mac is key to the attempts to ease stresses in the housing market, and this makes the implicit government support for the entities even stronger, analysts say.
The bill also codifies procedures for dealing with an insolvency at Fannie Mae or Freddie Mac, should it occur, Credit Suisse analysts said in a report on Thursday.
The legislation "would effectively lower the worst-case outcome to a nationalization of the GSEs rather than a forced unwind of the enterprise in the unlikely event of GSE insolvency," analysts at Credit Suisse said in a report on Thursday.
For now, however, the markets are still looking for more explicit support of the mortgage companies.
"Despite all the reassurances from the Fed, Treasury and U.S. Congressmen today, there is no specificity of any action plan," said Kleinbaum.
"Either Congress needs to step in and appropriate capital for these entities or they need to transfer the holdings to a new entity that is not publicly traded but is backed by Washington. I think those are the two practical solutions," he said.
"The market will continue to be nervous until something certain is done," said Scott MacDonald, director of research at Aladdin Capital in Stamford, Connecticut.
(Reporting by Karen Brettell; Editing by James Dalgleish)
