August 22, 2008 / 3:40 PM / 11 years ago

Moody's ratings cut latest blow to Fannie, Freddie

NEW YORK (Reuters) - A major credit rating agency cut the preferred share rating on Fannie Mae and Freddie Mac amid mounting concern about the ability of the two largest U.S. home funding providers to access capital, in the latest blow before a widely expected government bailout.

The headquarters of Freddie Mac are pictured in McLean, Virginia, May 14, 2008. REUTERS/Jason Reed

Early in the day, influential stock market investor Warren Buffett told CNBC there is a “reasonable chance” that Fannie Mae and Freddie Mac stock will get wiped out in a government rescue, reflecting market sentiment that has slammed the companies’ shares toward 20-year lows this week. The shares closed mixed on Friday.

In the ratings cut, Moody’s Investors Service cited concern that market turmoil has hurt the mortgage finance giants’ ability to get fresh capital. Moody’s made a ratings adjustment that suggests a greater likelihood the government sponsored enterprises, called GSEs, will need “extraordinary financial assistance” from the government or shareholders.

“Given recent market movement, Moody’s believes these firms currently have limited access to common and preferred equity capital at economically attractive terms,” Moody’s analysts said.

Many analysts expect the government will have to exercise new abilities to recapitalize the companies, effectively nationalizing them. Those worries yanked their stock closer to zero this week from more than $65 a year ago.

Fannie Mae shares rose 2 percent to $4.98 while Freddie Mac stock dropped 4 percent to $3.03. Freddie’s shares had fallen about 20 percent at one point on Friday.

A source familiar with Treasury’s thinking said on Friday that any backstop would aim to keep the shareholder-owned status of these GSEs, erasing sharper earlier losses.

The debt these companies issue to fund their mortgage purchases benefited, in contrast, from the view that a federal rescue assures repayment for bonds even if not for shareholders. Fannie and Freddie own or back nearly half of all outstanding U.S. mortgages.

“The institutions are too big to fail and the government needs them operating,” said Jeff Given, portfolio manager at MFC Global Investment Management in Boston. “It’s the only part of the mortgage market that’s even remotely working right now.

“At the end of the day probably the U.S. government’s going to come in,” he added. “I wouldn’t want to be a preferred share owner or a common stock owner, but if you own the debt or the MBS you’re going to be okay.”

Moody’s lowered the preferred stock ratings on the companies to “Baa3” from “A1,” and the bank financial strength rating to “D-plus” from “B-minus,” it said in a statement.

Investors have pummeled common and preferred shares of Fannie and Freddie during the past two months as speculation grew that losses on their mortgage holdings and guarantees are quickly eating away at their capital.

Moody’s added that Fannie and Freddie are restricted in their ability to support the worst U.S. housing market since the Great Depression. This difficulty comes just as the government is depending more heavily on the two companies to buy mortgages and stabilize housing and the economy.

At current share prices, “it’s a very cheap call on the notion of these guys surviving, and if they do it’ll be a multi-bagger payoff,” said Chuck Gabriel, managing director, Capital Alpha Partners, LLC in Washington.

Freddie Mac has said it intends to raise $5.5 billion in new capital and awaits more opportune market conditions.

“Our management has been talking with a variety of potential investors this week,” Freddie Mac Spokesman Douglas Duvall told Reuters on Friday, although he reiterated earlier statements that “we are capitalized above regulatory requirements.”

Fannie’s and Freddie’s ease in funding mortgages through the debt issuance is considered crucial for the housing market and economy.

Plenty of investors surfaced for new note issues sold this month by both companies, although Fannie and Freddie paid higher risk premiums than in prior sales.

The two GSEs have reported losses for the past four quarters, and rising mortgage delinquencies erode the value of their capital and assets. However, they meet regulatory capital requirements and are successfully rolling over debt on schedule, limiting the need for any nationalization.

Moody’s affirmed the companies’ “Aaa” senior debt ratings, and the “Aa2” rating on their subordinated debt.

In a sign that investors believe a bailout is on the way, risk premiums on most Fannie and Freddie senior debt sold to finance their mortgage purchases have fallen by as much as 0.25 percentage point versus Treasuries this week, returning to levels seen at the end of July.

“Most parties would look at it as the U.S. government stepping in and guaranteeing the obligations of Fannie and Freddie,” said Bob Pickel, chief executive of trade organization the International Swaps and Derivatives Association.

Large U.S. banks and thrifts that have disclosed holdings of Fannie and Freddie preferred stock and subordinated debt appear to have “manageable” exposure to potential write-downs, with the exception of Sovereign Bancorp Inc, according to report from CreditSights Inc late Thursday.

“Assuming that these securities are relatively well dispersed among the banking system, our view is that this should be a manageable exposure for most banks,” CreditSights analysts led by David Hendler wrote.

Additional reporting by Al Yoon, Elinor Comlay and Jonathan Stempel in New York, Patrick Rucker in Washington

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