Freddie Debt Sale Eases Fears of Government Takeover

Shares of Fannie Mae and Freddie Mac soared Monday after Freddie completed a $2 billion debt sale and a Wall Street analyst said a government bailout of the mortgage finance giants may not be inevitable.

CNBC

But regional banks with significant holdings in Fannie and Freddie preferred stocks followed the rest of the market down amid questions over whether federal regulators would step in to rescue the two government-sponsored companies.

Citigroup analyst Bradley Ball said that federal bailouts "don't necessarily wipe out all" company shareholders, and that Fannie and Freddie still have options despite their steep stock declines in recent weeks.

"We are not convinced that (the government) needs to take any action over the near term," Ball wrote.

But Len Blum, managing director and partner at investment bank Westwood Capital in New York, said Monday's rebound is likely to be temporary, as the companies' ability to raise capital on their own appears uncertain.

"The market thinks they're going to be nationalized," Blum said. "People have confidence in the debt, not the equity."

Freddie's sale of $2 billion in short-term debt was well received on Wall Street, but the company had to sweeten terms of the offer to lure demand, investors said.

Meanwhile, JPMorgan Chase disclosed Monday that it held about $1.2 billion of Fannie and Freddie preferred shares. It estimated the shares have lost about $600 million since the start of the quarter on July 1, based on their current market values.

For more commentary on the future of Fannie and Freddie see video at left

Regional banks with the largest exposure to Fannie and Freddie preferred stock as a proportion of their capital include Sovereign Bancorp , Westamerica Bancorp , Gateway Financial Holdings and Midwest Banc Holdings , according to a research note from Samuel Caldwell at Keefe, Bruyette & Woods.

Caldwell estimated that 38 regional banks together hold about $1.3 billion in preferred stock of Fannie and Freddie.

Banks in general are permitted to hold preferred shares as "core capital," which they use to guard against losses, said David Barr, a spokesman for the Federal Deposit Insurance Corp.

A government rescue of Fannie and Freddie -- whose share prices have plunged in recent weeks as they struggle with billions of dollars in losses from bad mortgages -- could be costly for scores of investment, banking and insurance companies that hold billions in their preferred shares.

The two companies had nearly $36 billion in preferred shares outstanding as of June 30, according to filings with the Securities and Exchange Commission.

With a total of $4 billion worth of Fannie and Freddie's preferred stock, U.S. insurance companies also are among the largest holders, according to A.M. Best Co. But that still represents less than 1 percent of reserves that the insurance industry holds against losses.

Preferred shares usually pay a fixed dividend and have priority over common stock when it comes to dividends and bankruptcy liquidation.

While slightly riskier than bonds, which have the highest priority in times of trouble, companies often invest in preferred shares for certain tax advantages.

Still, on Wall Street, Fannie and Freddie's existing preferred shares are trading like junk bonds, yielding around 17 percent to 19 percent instead of around their 6 percent dividend levels.

The higher yield is an inducement to investors to accept the higher level of risk that the dividends won't be paid.

© 2009 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.