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S& P Cuts Some Fannie, Freddie Ratings
Preferred Stock, Subordinated Debt Downgraded After Wider-Than-Expected Losses

By Jody Shenn
Bloomberg
Tuesday, August 12, 2008

Standard & Poor's cut the preferred stock and subordinated debt ratings of Fannie Mae and Freddie Mac, the two largest U.S. mortgage finance companies, after each last week reported wider quarterly losses than estimated.

The ratings at Fannie Mae and Freddie Mac both declined three levels to "A-" from "AA-," S&P said yesterday in separate statements. S&P affirmed the companies' "AAA" senior debt ratings, reflecting their perceived government support, and lowered rankings based on its assessment of the need for bailouts.

Government-chartered Fannie and Freddie, which account for almost half of the $12 trillion of U.S. residential mortgages, reported combined second-quarter losses of $3.1 billion last week, three times wider than analysts' estimates, in the latest capital-depleting deficits at the firms amid the housing slump.

"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," S&P analyst Victoria Wagner in New York wrote in the statement about Fannie.

The companies' reports prompted some investors to predict that Treasury Secretary Henry M. Paulson Jr. will be forced to use his new powers granted by Congress last month to support the companies through capital injections or debt purchases.

S&P placed non-senior debt from Fannie and Freddie under review for downgrade on July 25. The company ended that review yesterday and said the medium-term outlook for the rankings remain "negative."

S&P has begun automatically assigning ratings to the preferred shares and subordinated debt below the companies' risk-to-government ratings, which both fell to "A," the unit of McGraw-Hill said. The change reflects a federal law enacted last month, which allows a regulator for the companies to place them into receivership if their finances were to weaken significantly.

"That would place the nonsenior creditors of Freddie Mac at a greater risk of nonpayment, especially the dividend payments on preferred stock," S&P said.

Any U.S. equity injections into the companies allowed under the law would probably raise the odds of defaults on their subordinated debt, S&P said.

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