S&P Lowers Fannie, Freddie Citing Reliance on Government

Standard & Poor’s lowered credit ratings on debt issued by U.S.-backed lenders including mortgage giants Fannie Mae and Freddie Mac, citing its own Aug. 5 downgrade of the federal government’s AAA status.

Fannie Mae and Freddie Mac, which own or guarantee more than half of the almost $11 trillion in outstanding U.S. mortgage debt, were lowered one step from AAA to AA+, S&P said in a statement today. The downgrade reflects their “direct reliance on the U.S. government,” the ratings firm said.

The two companies have operated under U.S. conservatorship since September 2008, when they were seized amid subprime mortgage losses that pushed them toward insolvency. Since then, the government-sponsored enterprises have drawn almost $170 billion in Treasury Department aid.

In cutting the nation’s credit rating on Aug. 5, S&P faulted lawmakers for failing to reduce spending or increase revenue enough to reduce the nation’s budget deficit. Banking regulators including the Federal Deposit Insurance Corp. said that day that government-issued securities would be unaffected by the sovereign downgrade.

The Federal Housing Finance Agency, which regulates Fannie Mae, Freddie Mac and the Federal Home Loan Banks, sought to assure investors that the companies’ bonds were sound.

The Treasury’s commitment to provide capital to Fannie Mae and Freddie Mac “remains unaffected by the Standard and Poor’s action,” FHFA Acting Director Edward J. DeMarco said today in a written statement.

Fannie Mae, in a Securities and Exchange Commission filing, said it “could not predict the ultimate impact” of the downgrade on its operations or financial condition.

Borrowing Costs

Because the U.S. government -- through lenders including Washington-based Fannie Mae, Freddie Mac of McLean, Virginia, and the home loan banks -- is the country’s central source of mortgage funding, the downgrade could lead to higher borrowing costs for homebuyers.

More important, analysts say, S&P’s move adds volatility to a market already buffeted by foreclosures, losses at the two GSEs and stagnant home prices. The U.S. Census Bureau reported last month that the nation’s homeownership rate fell to 65.9 percent, the lowest level since 1998.

“The issue isn’t necessarily where mortgage rates land, it’s the uncertainty that this kind of thing engenders in the market, and that creates fear and panic selling,” said Clifford Rossi, a former Citigroup Inc. (C) chief risk officer who is now executive-in-residence at the University of Maryland’s Center for Financial Policy. “Until we can get some sort of stability, it’s keeping people on the sidelines,” he said.

Bond Yields

Yields on GSE bonds jumped to their highest relative to U.S. Treasuries in more than two years. The downgrade was only part of the reason for the wider spreads, said Walt Schmidt, a mortgage strategist in Chicago at FTN Financial, in a note to clients. The spreads are “based on uncertainties regarding prepayments and supply, not credit-based downgrade fears,” Schmidt said.

S&P, a unit of New York-based McGraw-Hill Cos., today also downgraded the long-term senior debt of 10 of the 12 home loan banks, from AAA to AA+. Home loan banks sell bonds and provide liquidity to banks and mortgage investors. The banks’ debt has an implied government guarantee.

“The FHLB system is classified as being almost certain to receive government support if necessary,” S&P said.

Chicago, Seattle

The ratings firm didn’t downgrade the home-loan banks of Chicago and Seattle, which were already rated AA+. The home loan bank system had more than $809 billion in assets and $551 billion in outstanding bonds at the end of June.

S&P also lowered, by a notch, senior debt issued by the Farm Credit System, which guarantees agriculture-related loans, 126 securities guaranteed by the FDIC and four securities from a National Credit Union Association, which guarantees credit union deposits.

Moody’s Investors Service, an S&P competitor, reiterated its Aaa bond rating of U.S. sovereign and related debt on Aug. 3, after lawmakers and the White House agreed to raise the nation’s $14.3 trillion debt ceiling.

To contact the reporter on this story: Lorraine Woellert in Washington at lwoellert@bloomberg.net

To contact the editor responsible for this story: Lawrence Roberts at lroberts13@bloomberg.net

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