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Investors Fretting About Rescue Of Fannie, Freddie

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The Associated Press

The Tampa Tribune

Published: August 22, 2008

WASHINGTON - A government rescue of Fannie Mae and Freddie Mac could be costly for scores of investment, banking and insurance companies that hold billions of dollars in preferred shares in the mortgage finance giants.

Speculation has been building on Wall Street that a government investment to rescue Fannie and Freddie would come in the form of a cash infusion through the acquisition of preferred shares in the companies.
Preferred shares usually pay a fixed dividend and have priority over common stock when it comes to dividends and bankruptcy liquidation. Although slightly riskier than bonds, which have the highest priority in times of trouble, companies often invest in preferred shares for certain tax advantages.

Investors appear to think existing common stockholders could be wiped out if there is a government bailout. Fannie and Freddie's shares have lost more than 90 percent of their value this year.

On Thursday, Fannie Mae's stock rebounded, rising 45 cents, or 10.2 percent, to close at $4.85, while Freddie Mac fell 9 cents, or 2.8 percent, to $3.16.

But what happens to preferred stockholders is less certain.

"That depends on how big Fannie and Freddie blow up," said Michael Shedlock, an investment adviser for SitkaPacific Capital Management.

On Wall Street, investors think it could be big. Fannie and Freddie's existing preferred shares are trading like junk bonds: yielding about 17 percent to 19 percent instead of their 6 percent dividend levels. The higher yield is an inducement to investors to accept the higher level of risk that the companies won't be able to pay their dividends.

"There's enormous investor concern," said Bert Ely, an Alexandria, Va., banking industry consultant.
Fannie Mae has 17 classes of preferred stock, with more than 600 million shares outstanding. Freddie Mac has 24 classes of preferred stock, with about 460 million shares outstanding.
Congressional analysts estimate a government rescue of the mortgage giants could cost taxpayers $25 billion, with the exact amount based on how far the U.S. housing market falls and how severe the financial situation turns out to be in the long run.

Another uncertainty is political: The final resolution of Fannie and Freddie's future is likely to be determined after the Bush administration leaves office in January. It remains unclear how much in taxpayer resources the next administration and Congress would be willing to commit.

"The problem is: We've got questions. We don't have answers," said Hugh Johnson, chairman and chief investment officer of Johnson Illington Advisors in Albany, N.Y.

The financial industry is trying to figure out what will happen to Fannie and Freddie because their stocks and bonds are so widely held, said Tony Plath, an associate professor of finance at the University of North Carolina at Charlotte.

"There's not protection for shareholders of common or preferred shares," he said.

But some believe that a rescue of Fannie and Freddie could be good for preferred shareholders.

"Even if any rescue effort gives a priority to the federal government ... that still makes Fannie and Freddie more solvent," said James Cox, a Duke University securities law professor. So preferred shareholders could see the value of their investments rise, he explained.

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

"While some companies will probably have some writedowns, I don't think there's a widespread effect on the whole industry," said Edward Keane, senior financial analyst with A.M. Best.

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