Lenders' rescue plan could cut values
Preferred shares may be at risk
WASHINGTON - A government rescue of Fannie Mae and Freddie Mac could be costly for scores of investment, banking, and insurance companies that hold billions in preferred shares of the mortgage finance giants as assets.
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.
Those shares, which pay a bond-like yield, get preference over common shares in the event a company is liquidated.
While existing common stockholders would likely see the value of their stakes reduced to zero, the outcome is less certain for preferred shareholders.
"That depends on how big Fannie and Freddie blow up," said Michael Shedlock, an investment adviser for SitkaPacific Capital Management who writes the financial blog "Mish's Global Economic Trend Analysis."
With Fannie and Freddie's existing preferred shares paying yields of around 17 percent to 19 percent, compared with original yields of about 6 percent, credit markets are indicating that "some hit is going to come from existing preferred shareholders," Shedlock said.
Investors generally believe that stakes in Fannie and Freddie's debt would be protected under any government rescue plan.
But congressional analysts estimate a government rescue of the mortgage giants could cost taxpayers $25 billion, with the exact amount based on how far the housing market falls and how severe their financial situation turns out to be in the long run.
Tony Plath, an associate professor of finance at the University of North Carolina at Charlotte, said the entire financial industry is trying to figure out what will happen to Fannie and Freddie because investment in their equity and debt is so widespread.
"There's not protection for shareholders of common or preferred shares," he said.
The US insurance industry has $4 billion in exposure to Fannie and Freddie's preferred stock, according to A.M. Best Co. Inc. But that represents less than 1 percent of the surplus the industry holds against losses.
Fannie and Freddie are the largest source of funding for home mortgages in the United States. But they have struggled with soaring losses from mortgage defaults. Washington-based Fannie and McLean, Va.-based Freddie, have lost a combined $3.1 billion between April and June, and investors fear the losses will continue to grow.
Fannie Mae shares rose 45 cents, or 8 percent, to $4.85, while Freddie Mac fell 9 cents, or 4 percent, to $3.15 on the New York Stock Exchange. 