S&P cuts Fannie, Freddie preferred stock

NEW YORK (Reuters) - Standard & Poor's on Monday slashed the preferred stock ratings of Fannie Mae (FNM.N) and Freddie Mac (FRE.N), and said the U.S. mortgage funding giants presented a greater risk to the government.

The rating company cut the ratings after the two Congressionally chartered companies reported increased credit losses for the second quarter, and also following creation of a new regulatory structure that places holders of subordinated debt and preferred stock at a disadvantage.

Preferred stock and subordinated debt ratings for both companies were downgraded three notches to "A-minus" from "AA-minus."

Fannie Mae's risk-to-the-government rating was lowered to "A" from "A-plus," while the designation for Freddie Mac was cut to "A" from "AA-minus," according to S&P. The rating measures a company's creditworthiness without government support.

"The lower risk-to-the-government rating reflects the company's worsening financial profile, which is pressured by the continued home price declines in some of its key markets, higher credit-related expenses, and capital challenges," Victoria Wagner, an S&P analyst said in a statement.

Higher operating losses and capital concerns are also behind the Freddie Mac downgrades, Wagner said in a separate statement.

Fannie Mae and Freddie Mac last week reported deeper-than-expected second-quarter losses due to rising mortgage defaults and foreclosures. Expectations for more losses led both to sharply reduce dividends in a bid to conserve capital, which they also need to continue filling a hole of mortgage funding left by other financial institutions frozen by the global credit crisis.

Freddie Mac last week said it expects to raise $5.5 billion in capital, and S&P said uncertain demand from credit markets for Freddie Mac capital issuance could imperil its position.

Credit losses for Fannie Mae will likely reach record highs of 23 basis points to 26 basis points, exceeding those seen in the Texas banking crisis of the early 1980s, it said. Freddie Mac losses will also exceed levels of the 1980s, it said.

Cuts to subordinated debt and preferred stock ratings follow legislation that gives powers of receivership to their new regulator. Receivership could put non-senior creditors at a greater risk of nonpayment, especially dividend payments on preferred stock, S&P said.

S&P affirmed the "AAA" senior unsecured debt rating of Fannie Mae and Freddie Mac, citing explicit support for the companies in a sweeping housing bill that offers them funding alternatives from the Treasury.

The use of Treasury funds could put subordinated creditors of the companies at even greater risk, S&P said.

The cost to protect subordinated debt of Fannie Mae and Freddie Mac rose after the S&P cuts. Five-year credit default swaps for Fannie Mae subordinated debt widened to 258 basis points, or $258,000 a year on $10 million in debt, from 247 basis points on Friday, according to CMA DataVision.

(Reporting by Al Yoon; additional reporting by Walden Siew, Editing by Chizu Nomiyama)