S&P's Actions on Fannie Mae, Freddie Mac

S&P upheld its triple-A debt ratings on the mortgage giants in the wake of the government takeover but slashed companies' preferred stock to junk

On Sept. 7, Standard & Poor's Ratings Services said it affirmed its long-term AAA and short-term A-1+ senior unsecured debt ratings on Fannie Mae (FNM) and Freddie Mac (FRE). The outlook is stable.

At the same time, S&P lowered its "risk-to-the-government standalone issuer" credit ratings on Fannie Mae and Freddie Mac to R (regulatory supervision) from A- and withdrew the ratings. It also revised the CreditWatch listing of the BBB+ subordinated debt ratings on these entities to positive from negative. In addition, it 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.

These rating actions follow the Sept. 7 announcement by the U.S. Treasury Dept. that Fannie Mae and Freddie Mac have been placed in conservatorship by their regulator, the Federal Housing Finance Agency (FHFA).

"Our affirmation of the long-term 'AAA' and short-term 'A-1+' senior unsecured debt ratings reflects the explicit government support under the terms of the conservatorship and Treasury's establishment of a preferred stock purchase agreement," said Standard & Poor's credit analyst Victoria Wagner.

Standard & Poor's believes the government has now clearly reinforced its support of the two government-sponsored enterprises (GSEs). The government's action underscores the importance it places on the GSEs, as well as its apparent belief that the companies' mortgage franchises are viable and critical to the financing of the U.S. mortgage market and the overall economy.

Standard & Poor's lowered and withdrew the risk-to-the-government ratings because of the conservatorship, with the FHFA acting as conservator with full control and oversight of the GSEs' businesses. Under a conservatorship, the FHFA takes over the assets of and operates the GSEs with all of the powers of the shareholders, the directors, and the officers and conducts all business including authorizing the payment of valid obligations as outlined in the recently passed Housing and Economic Recovery Act of 2008.

The CreditWatch positive on the subordinated debt reflects S&P's view that there is strong regulatory support for the continued timely payment of this debt. If regulatory capital drops to a level that would breach regulatory minimum levels, S&P expects the subordinated debt's interest deferral covenant will be waived, increasing the likelihood of timely payment. Furthermore, there are no covenants restricting the payment of interest on the subordinated debentures while the preferred dividends are suspended. S&P could raise the subordinated debt ratings once further information is available on the support that may be provided to Fannie Mae and Freddie Mac's subordinated debtholders while the GSEs remain in conservatorship and post-conservatorship. Alternatively, upon final review of the status and support for subordinated debt payments, S&P could affirm these ratings. The CreditWatch listing of the subordinated debt will be resolved upon review of the final terms of support outlined in Treasury's backstop plan for the GSEs.

The downgrade of the preferred stock ratings reflects FHFA's announcement that dividends on the preferred stock are being eliminated in view of the GSEs' weak near-term earnings prospects and the need to preserve capital.

Separately, S&P Ratings said on Sept. 7 that neither its AAA/A-1+ sovereign credit rating on the United States of America, nor its stable outlook on these ratings is affected by the U.S. Treasury's decision to put Fannie Mae and Freddie Mac into conservatorship. In S&P's view, the U.S. government's credit quality continues to be upheld by its high-income, highly diversified, and exceptionally flexible economy, relative to those of other AAA rated sovereigns, together with the U.S. public sector's fiscal flexibility and the unique advantages coming from the dollar's preeminent place among currencies.

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