Shareholding banks to be hit

Lenders with big stakes may need a boost

Sovereign Bancorp Inc., Gateway Financial Holdings Inc., and lenders with "significant" stakes in Fannie Mae and Freddie Mac may be left grasping for capital after the US government seized the mortgage companies and placed them into conservatorship.

The takeover replaced the government-sponsored companies' chief executives and eliminated their dividends, leaving preferred shareholders second in line for claims and holders of common stock last. US bank regulators may be concerned the market will conclude smaller banks' capital will be completely depleted, said Ira Jersey, a Credit Suisse Holdings USA Inc. interest-rate strategist.

"While the preferreds aren't being formally wiped out, their value is largely gone," Sterne Agee & Leach Inc. analyst Sean Ryan said. The takeover has "pretty ugly implications for capital adequacy" for some lenders, he said.

Some smaller lenders that bought preferred stock to cushion loan losses have holdings valued at a significant percentage of their capital. Banks that don't maintain minimum capital levels against losses may face curbs on their business, dividends, and management, and in some cases can be shut down.

The Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, and the Office of Thrift Supervision said they would work with those lenders on "capital restoration plans."

Sovereign, the second-largest US savings and loan, had stakes in Fannie and Freddie valued at $623 million as of June 30 and said it may take "significant" charges on its holdings. The Philadelphia-based bank's stakes are "not technically part of our capital," and are "simply within our investment portfolio," chief financial officer Kirk Walters said in an August interview.

"When we raised $1.9 billion in new regulatory capital in May, a number of factors were taken into consideration including a possible decline in our investments," said Sovereign chief executive Joseph Campanelli in an e-mailed statement. "Sovereign is well capitalized and even in a worst-case scenario, would remain so and have adequate cushion under all regulatory standards."

The takeover is "unambiguously bad" for preferred shareholders who, along with holders of common stock, "will in all likelihood be wiped out," Gimme Credit LLC analyst Kathleen Shanley said. "The government opted not to sweeten the pill for bank holders of preferred stock," and the move is "likely to set a precedent for any future rescue transactions," she said.

Money managers holding shares of Freddie and Fannie also will be affected.

Fidelity Investments, Wellington Management Co., and Dodge & Cox topped the list of money managers loading up on Fannie Mae and Freddie Mac in the second quarter before the mortgage lenders lost a combined $18.9 billion in value.

Of the firms that boosted their stakes in Fannie Mae, Fidelity, the world's largest mutual fund manager; Wellington, the Boston-based hedge fund company; and San Francisco-based Dodge & Cox added the most, according to data from June 30 government filings compiled by Bloomberg. Wellington was the biggest buyer of Freddie Mac on a net basis among fund firms.

Investors who bought on speculation the government would rescue shareholders bet wrong after the stocks tumbled more than 60 percent in the third quarter through last week. Treasury Secretary Henry Paulson said Sunday the government will take over the companies by taking 79.9 percent of the common stock and all their dividends in return for buying $1 billion of preferred shares. Common shareholders are "last in line" for claims on Fannie and Freddie and will bear losses ahead of a new series of government preferred stock, he said.

"The payoff would have been high if there had been a government bailout, but that wasn't the case," said John Davidson, president of PartnerRe Asset Management in Greenwich, Conn. "If you haven't prepared investors, then I think the clients will want new managers."

"This is a disaster for anyone who bought the stock," said Jack Ablin, who helps manage $65 billion as chief investment officer at Harris Private Bank in Chicago. "Based on what we know so far it seems like the stock is worth virtually nothing."

Adam Banker, a spokesman for Boston-based Fidelity, and Wellington's Lisa Finkel said their firms' policies are not to comment on individual holdings.

Dodge & Cox spokesman Steve Gorski said "we are currently studying the implications of the unprecedented action by the Treasury Department and the FHFA and are reviewing our options."