The crisis of confidence surrounding Fannie Mae (FNM) and Freddie Mac (FRE) culminated on Sept. 7 when the regulator of both government-sponsored entities (GSEs), the Federal Housing Finance Agency (FHFA), placed them under a regulatory conservatorship. We believe this was a preemptive move, intended to remove a major uncertainty contributing to market turmoil and to ensure the GSEs can fulfill their public policy role of providing liquidity to the U.S. mortgage market. Although the GSEs were in capital compliance and had access to funding, they faced further financial and capital stress in the midst of the historically weak U.S. housing market.
The government's main concerns about Fannie and Freddie appear to have been their capital strength and the market's reaction to heightened uncertainty about how and when the U.S. Treasury Dept. would exercise its newly enacted liquidity-backstop plan. The GSEs were evidently placed under conservatorship to reduce systemic risk to the broader global financial markets. The aim also was apparently to restore the GSEs' capacity to fulfill their role of providing liquidity to the U.S. mortgage market through Treasury's new liquidity facilities and the new senior preferred stock purchase agreement it made with each GSE. Standard & Poor's Ratings Services understands that the Treasury actions were taken with three key objectives: market stability, market availability, and taxpayer protection.
While we view this action as generally positive, the conservatorship raises immediate questions for the operations of Fannie Mae and Freddie Mac and for the broader financial-institutions sector. Overall, however, we believe that Treasury, FHFA, and banking regulators will work together to bolster the financial sector and capital markets. Clearly, senior and subordinated debtholders are protected under the conservatorship, while holders of preferred and common stock may suffer disproportionately. Here are our views regarding some of those questions.
What was the impact on the credit ratings of Fannie Mae and Freddie Mac?
We affirmed our long-term AAA and short-term A-1+ senior unsecured debt ratings on Fannie Mae and Freddie Mac. The outlook is stable. At the same time, we lowered our risk-to-the-government stand-alone issuer credit ratings on Fannie Mae and Freddie Mac to R (regulatory supervision) from A- and withdrew the ratings. We have also revised the CreditWatch listing of the BBB+ subordinated debt ratings on these entities to positive from negative. In addition, we lowered the preferred stock ratings to C from BBB- and removed the ratings from CreditWatch with negative implications. The subordinated debt and preferred stock ratings were originally placed on CreditWatch on Aug. 26, 2008.
What does a C rating on the preferred stock mean?
The C rating reflects the cessation of dividend payments on these securities. Fannie Mae and Freddie Mac have issued only noncumulative perpetual preferred stock, in which unpaid dividends do not accumulate. This is the only type of preferred stock that is eligible for regulatory capital purposes. Under the terms of the Senior Preferred Purchase Agreement, there is a covenant prohibiting the payment of dividends on existing preferred stock (other than the newly issued senior preferred stock) and common stock. It is currently difficult to assess the status of any resumption of dividend payments.
What is the form of Treasury liquidity and equity support to the GSEs that led to Standard & Poor's affirmation of the senior unsecured debt ratings?
Over and above general statements of support by Treasury that confirm the GSEs' viability and their pivotal role in the U.S. mortgage markets, the department also announced two forms of liquidity support for the GSEs and a senior preferred stock purchase agreement to provide equity support for them. It was these explicit actions of support for GSE debt that led to our affirmation of the senior debt ratings and the placement of subordinated debt on CreditWatch Positive. The new Treasury actions are:
•A senior preferred stock purchase agreement pursuant to which Treasury will purchase senior preferred stock from Fannie Mae and Freddie Mac on an as-needed basis; the program size is up to $100 billion of issuance per GSE. These preferred securities will rank senior to all existing preferred stock. Commencing Mar. 31, 2010, the GSEs will pay Treasury quarterly a periodic commitment fee in the form of either cash or a payment in kind. This program does not have an expiration date. Clearly, this outsize amount should put to rest market concerns regarding potential financial support the GSEs may need in the future.