Moody’s Cutting GSE’s, The Ride Continues (FNM, FRE)

Moody’s has come out with a downgrade this morning on the preferred stock ratings of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE).  The ratings have been taken down to Baa3 from A1 and the Bank Financial Strength Ratings to D+ from B-. The preferred stock ratings and BFSRs also both remain on review for possible further downgrade. There may be a little bit of a silver lining to this though.  Fannie Mae’s and Freddie Mac’s Aaa senior long-term debt and Prime-1 short-term debt ratings were affirmed with stable outlooks.   

Here are the actual cuts with the remaining on review for possible downgrade:

• Fannie Mae and Freddie Mac — Bank financial strength rating to D+ from B-; Preferred stock to Baa3 from A1.

The following ratings were affirmed with a stable outlook:

•  Fannie Mae and Freddie Mac – Senior long-term debt at Aaa; Short-term debt at Prime-1.

The following rating was affirmed with a negative outlook:

•  Fannie Mae and Freddie Mac – Subordinated debt at Aa2.
• The firms’ Aa2 subordinated debt ratings were affirmed, but the outlook was changed to negative from stable.

The BFSR downgrades reflect the ratings agency views that Fannie Mae’sand Freddie Mac’s financial flexibility to manage potential volatilityin its mortgage risk exposures is constricted as the agency believesthe GSE’s have limited access to common and preferred equity capital atattractive terms.

The limited flexibility also is noted as restricting their ability topursue providing liquidity, stability and affordability to the UShousing market.

Fannie Mae and Freddie Mac currently make up approximately 75% of themortgage market in the US and a reduction in the capacity of thesefirms to support the US mortgage market could have significant repercussions for the US economy. Moody’s also noted thatit believes the likelihood of direct support from the United StatesTreasury has increased.

Fannie Mae’s and Freddie Mac’s Aaa senior long-term, Prime-1 short-termand Aa2 subordinated debt ratings were affirmed.  Moody’s also views itas unlikely that the US Treasury would allow Fannie Mae or Freddie Mac to defer payment on a debt instrument given potential market ramifications.

Fannie Mae shares were up but have fallen on this report as shares arenow down about 7% at $4.50.  Freddie Mac shares are also kicked as theyare now down 10% at $2.83.

As a reminder, Warren Buffett just this morning noted how these could be wiped out entirely on the common stock but noted that the government wouldn’t let them fail as an entity.

Jon C. Ogg
August 22, 2008