A Preferred Problem; Fannie, Freddie Downgrades Loom Large

Discussing the imminent future of either mortgage financial giant Fannie Mae (FNM) or Freddie Mac (FRE) these days is one thing; analysts remain strongly split over what lies in the crystal ball. But discussing the effect of recent ratings downgrades to the preferred shares of both companies is another thing entirely. And unlike the discussion over future operations, it’s becoming clear that holding preferred interests in either GSE is going to be hazardous to Q3 earnings. On Tuesday, Standard & Poor’s Ratings Services lowered Fannie and Freddie’s preferred stock rating to ‘BBB-‘ from ‘A-,’ while cutting a host of other ratings as well, and warning that further cuts may be coming in the future. The ratings agency said it cut the ratings over “increasing uncertainty about whether government support will extend to these securities in the context of further deterioration” in each GSE’s assets. JP Morgan Chase & Co. (JPM) said late Monday in a filing with the Securities and Exchange Commission that it held approximately $1.2 billion par value of Fannie Mae and Freddie Mac perpetual preferred stock — now worth just $600 million. The firm was the first large financial and major Wall Street firm to make such a disclosure, but it won’t be the last. CEO Jamie Dimon has consistently kept his firm at the forefont of the credit crisis, staying well ahead of analyst and investor expectations; it’s a straight-shooting reputation the firm has developed that has served it very well within and outside of the Street, relative to peers. As HW originally reported, Dimon famously said in a Q2 earnings call that prime mortgages looked “terrible.” The firm then disclosed an additional $1.5 billion MBS hit in July, while filing its 10-Q for the second quarter on Aug. 12. Shares in JP Morgan rose 1.33 percent Tuesday to close at $36.61. Other large shareholders are sure to report similar marks to their investment portfolio; among them is FMR, LLC, the parent of Fidelity Investments. FMR held more than $1.5 billion in common shares of Fannie and Freddie, according to SEC filings. Also in the group is Wells Fargo & Co. (WFC), which holds a large preferred share position as well. And, of course, there are more than a few smaller banks with positions in Fannie and Freddie stock that appear set to suffer as well: the New York Times on Monday cited Sovereign Bancorp (SOV), a regional lender in the Philadelphia area, as well as Midwest Banc Holdings (MBHI), a community bank in Illinois, as other key holders of preferred shares in the GSEs. Related links: S&P Fannie cut, S&P Freddie cut Disclosure: The author was long FRE and held no other relevant positions when this story was published; indirect holdings may exist via mutual fund investments, as well. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.