Barrons article 1 Final Test for Fannie and Freddie: The piece, which laid out the near-inevitability of a government bailout of the mortgage giants, was widely cited as a key factor in the bigger-than-2% drop in U.S. and major world stock markets on Monday and Tuesday. The stocks of Fannie Mae (ticker: FNM) and Freddie Mac (FRE) both fell more than 40% for the week, to price levels not seen in nearly two decades. The companies' two most recent preferred issues are now trading at a highly distressed dividend yield of around 19%. How the crisis will play out from here is uncertain only as to timing rather than outcome. Exercising newly-granted authority, the Treasury Department will have to step in soon to rescue both agencies with an equity infusion because their stocks have shriveled to a combined market capitalization of around $7 billion. Ruinous dilution precludes their raising even $20 billion, let alone filling the $100 billion hole in negative equity that we estimate exists in their combined balance sheet. As we spelled out in the story, the government bailout would come in the form of a purchase of senior preferred stock with conversion rights that would effectively wipe out the existing common stock and a dividend priority that would choke off dividends to the existing preferred stock for some time, if not forever. Even though the government last month made explicit for the first time its backing of all Fannie and Freddie senior debt, Freddie last Tuesday had to pay a record 1.13 percentage-point premium over the comparable Treasury on a five-year note. But the real test for Fannie and Freddie will come over the next five weeks when, according to Barclays Capital, the pair will have to raise and roll over $225 billion of mostly short-term debt. An immediate rescue would be necessary should either agency run into problems raising the money. Barron's has been highlighting the companies' woes for months ("The Next Government Bailout?" -- March 10). The management teams of both companies indulged in reckless speculation on the taxpayers' dime, then obscured their actions with dubious accounting. At this point government takeover is not the problem -- it's the solution.
Barrons article 2 Why Saving Fan and Fred is a Priority: Laing's blockbuster last week, "The Endgame Nears for Fannie and Freddie." Securities of Fannie Mae (ticker: FNM) and Freddie Mac (FRE) were roiled by the story, which quoted a Bush administration source saying that unless the government-sponsored enterprises raised a "credible" amount of equity, some $10 billion each, a Treasury capital infusion that would wipe out the common shareholders would be increasingly likely. Given the long odds of that happening, Fannie and Freddie's preferred shares plunged along with the common (see Follow-Up on page 18 and The Trader on page M4 for the gory details) while their subordinated and senior debt issues also took a hit initially. But the senior debt recovered and ended the week stronger than where it started. The preferred shares came into focus Friday after Moody's Investors Service slashed its ratings five whole notches -- to Baa3, the last rung above junk, from A1, a respectable investment-grade rating. Yet the preferreds actually bounced in the wake of the Moody's action on the notion that the biggest losers if the preferreds were wiped out in a Treasury recapitalization of Fannie and Freddie would be scores of regional banks. Imperiling the financial strength of already shaky banks, even though they effectively doubled down on their bet on housing and real estate via the preferred, would only add to regulators' headaches. The GSEs' preferreds were pounded nearly as hard as the common for most of the week. But Friday, Fannie's series S preferred (FNM-S) was up 23 cents, or 2.1%, to 11.29. For the week, however, this actively traded preferred was down 25.7%, about two-thirds as big as the common's hit. Freddie's series Z preferred (FRE-Z) Friday popped 1.08, or 10.7%, to 11.20, but lost 26.6% on the week, or nearly half the halving in the common's value. Not only would regulators be concerned about the impact on banks from a wipeout of Fannie and Freddie preferreds, but they also probably would be mindful of what that could mean for the overall preferred market. This has been a major source of capital for beleaguered banks and brokers looking to shore up balance sheets devastated by subprime-related credit losses, one that regulators ought to be loath to cut off.
Barrons part 3 Similarly, the cost of insuring Fannie and Freddie subordinated debt blipped up initially but settled back. At the peak at midweek, their credit-default swaps hit 350 basis points (3.50 percentage points, equal to a cost of $350,000 to insure $10 million of debt against default for five years). By week's end, the CDS on Fannie and Freddie subordinated debt tightened to under 300 basis points. Meanwhile, CDS on Fannie and Freddie senior debt actually tightened 10 basis points, to 39 basis points, over the course of the week, according to Markit Inc., on the same assumption that battered the equities -- that the U.S. government would stand behind this debt. The key reason to pump taxpayer money into Fannie and Freddie is to ensure their senior debt and the mortgage-backed securities they insured continue to trade as gilt-edged quality. Their securities account for billions in assets of foreign central banks and other institutions that assume the federal government will stand behind the GSEs' debentures and MBS. Foreigners' willingness to hold U.S. paper is an important support for the dollar. Indeed, a former adviser to China's central bank said if Fannie and Freddie were allowed to fail, the consequences will be "catastrophic." Yu Yongding told Bloomberg News, "If it is not the end of the world, it is the end of the current international financial system." While that may be hyperbole, foreign central banks and other agencies have been quietly paring their holdings of U.S. agency securities, even after Treasury Secretary Henry Paulson outlined plans for the federal government to shore up Fannie and Freddie. Custody holdings of agencies at the New York Federal Reserve Bank had fallen to $984 million as of Wednesday from $975 million on July 20. Meanwhile, they sharply increased their holdings of Treasuries, to $1,430.9 billion from $1,364 billion over that period. Fannie and Freddie also have become the source of most new mortgage credit now that banks have tightened the availability of home loans, whether prime, subprime or something in between, according to the Fed's quarterly survey of loan officers. That's why preserving Fannie and Freddie, if not their shareholders, has become a priority in Washington.
Summary of four articles: (1) Bailout a matter of when, not if. (2) Paulson is working out the details of the bailout, hence the reason there has been no announcement. (3) The detail requiring most thought is - what effect will a wipeout of the preferred stock have on regional banks, that hold a lot of those securities? On one hand, Paulson may not want to hurt the banks, but on the other, it's tough to "sell" the concept that taxpayers will bailout preferred shareholders. (4) Common equity will diluted to zero, or very close to it.
With the <b>precedent</b> of Paulson throwing a few bones to Bear shareholders, first 2 then raised to 10, would anyone here risk estimates for a possible bailout? One suggested by a wise friend was 100% debt (senior, junior), 50% preferred, 90% common (about 3 to 6.5 per share) if high is considered 65.88. All assumptions, of course. Also, does anyone know if the 100/150 billion of Russia's holdings include any equities or just short/long term debt?
The Bear Stearns situation was different because it was a "genuine" takeover by JP Morgan Chase. So it was company money paying BSC shareholders. It's much harder to "sell" a non-zero takeover of FRE & FNM using taxpayers' money. Second, the $2 figure was about 7% of the share price on the preceding trading day. Using the same percentage, you get about 20 cents for FRE and about 35 cents for FNM. I don't think the Treasury could "sell" the payment of $3 or more per share for FRE, given that it closed below $3 on Friday.
Correct me if I am wrong but the company's money from JPM actually got backed by the government. Since the recently passed housing bill explicitly states the need to keep the GSE's as shareholder-owned, I was thinking this *bailout* will be no different: private money backed by a loan guarantee or similar, thus a few bones to shareholders. But as you said, it may not amount to much. Although in this scenario, shareholders such as Bill Miller may have a voice.
It would be very odd if common shareholders get wiped out but preferred gets to stay. I say all shareholders face 100% wipe-out along with all the management. Fannie and Freddie will be merged and transformed into a Gennie Mae type situation, within the Treasury Department. Banks holding preferred and that are already on the brink are going to go under anyway. It's actually quiet simple. If the Treasury Department did bailout fannie and freddie shareholders, the morale hazard would be too great.
Given: (1) the Friday Reuters leak about Paulson wanting to keep FNM and FRE as shareholder owned companies and (2) Concern about the impact of declining valued of preferred stock on the regional banks (Barrons article) this could give credence to the idea of a huge equity offering that doesn't completely wipe out existing shareholders, but dilutes them significantly. For example, preferred stock at share prices below $1. This would also partially address the 'moral hazard' problem - although shareholders may not be completely wiped out, they would suffer huge dilution. Given all the leaks since one week ago, professional money managers have had ample opportunity to get out of these stocks. The percentage of shares owned by Yahoo Messageboarders is increasing, as evidenced by the number of posts about the evils of shortsellers.
Cramer says the tape is lying today and he wouldn't touch FNM and FRE. Hmm... maybe a short term bottom is in. http://www.thestreet.com/_yahoo/funds/stoptrading/10434569.html?cm_ven=YAHOO&cm_cat=FREE&cm_ite=NA