Regulation

Freddie and Fannie Take S&P Ratings Hit

Outlook is negative, and risk-to-government rating is cited, but senior debt ratings of both are affirmed.
Stephen TaubAugust 11, 2008

Standard & Poor’s lowered its subordinated debt and preferred stock ratings on both Freddie Mac and Fannie Mae, and said the outlook for both companies is negative.

The debt rating agency cut Freddie’s ratings on the two classes, to ‘A-‘ from ‘AA-‘, and its risk-to-the-government rating to ‘A’ from ‘AA-‘. However, it affirmed the ‘AAA/Stable/A-1+’ senior unsecured debt rating on Freddie Mac.

“The lower risk-to-the-government, subordinated debt, and preferred stock ratings reflect Freddie Mac’s pressured capital position in the face of higher operating losses,” said Standard & Poor’s credit analyst Victoria Wagner. She explained the risk-to-the-government rating measures Freddie Mac’s “stand-alone” creditworthiness — its credit quality absent extraordinary government support.

The affirmation of Freddie’s senior debt rating reflects the strong explicit and implicit U.S. government support these securities hold in the marketplace, as evidenced by the recent U.S. Treasury actions, S&P said, adding: “This underscores the key public policy role and the key liquidity role the congressionally chartered government-sponsored enterprises (GSEs) have in the US mortgage market.”

S&P lowered Fannie’s preferred stock and subordinated debt rating to ‘A-‘ from ‘AA- and lowered its our risk-to-the-government rating to ‘A’ from ‘A+’. However, the rating agency affirmed its ‘AAA/Stable/A-1+’ senior debt rating on Fannie Mae, again citing its “strong explicit and implicit US government support these securities hold in the marketplace.”

S&P said the lower risk-to-the-government rating reflects Fannie’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.” The lower preferred stock and subordinated debt ratings reflect the greater subordination risk to the securities, as Fannie Mae now operates under a new regulatory regime as outlined in the passage of new legislation, S&P added. “These ratings also reflect the greater financial stress present in Fannie Mae’s core business,” said Wagner.

S&P said the new legislation goes a long way to clarify the regulatory framework of the GSEs, adding more depth to the regulatory authority and powers, which it said is positive for creditors. “It also has a provision that protects the Freddie Mac charter even in receivership,” it added.

The rating agency cautioned, however, that it will take time to develop and implement some of the new regulations, including new capital requirements.

S&P lamented in its report that the increase in Freddie’s credit losses in the recently reported second quarter was greater than the rating agency had anticipated. The second-quarter credit losses totaled $810 million, 53 percent higher than in the first quarter.

Although Fannie’s net revenues were higher in the second quarter due to wider net interest spreads, the rise of credit losses was even greater. “If capital ratios continue to be pressured beyond levels we now anticipate, or if capital-raising efforts fall short of the business needs, we could lower the ratings,” S&P warned in its Fannie report.

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