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  • September 9, 2008 08:50 AM EDT by Elizabeth MacDonald

    Banks Slammed By Treasury's Bailout

    The Treasury Department's bailout of Fannie Mae and Freddie Mac could ignite a cascade of sizable writedowns and losses at up to 40 banks around the country, analysts say.

    The reason is the Treasury did not adopt in its rescue of Fannie Mae (FNM) and Freddie Mac (FRE) a plan that would protect the value of the preferred shares, or the common stock, in the two mortgage giants.

    Fannie and Freddie own or guarantee about $5.4 tn in home loans--half the nation's total, and half the size of the US gross domestic product. Preferred shares are different than common stock, as they carry no voting rights, among other things.

    As a result, the Treasury Department's plan now threatens to blow open gaping potholes in dozens of bank balance sheets due to the resulting drops in value in Fannie and Freddie preferred shares.

    Because of the bailout, the preferred stock in Fannie and Freddie could eventually be worth just pennies on the dollar, or even zero, according to some analysts.

    And because of the looming losses, the regionals will be forced to either go hat in hand to, say, the private equity crowd, consolidate, merge, or go out of business--or, ironically, raise capital via more preferred share offerings.

    The potential write-downs and losses come after the Treasury Department and the Federal Housing Finance Agency seized control of the mortgage giants, in what is expected to be the world's biggest government bailout that effectively makes the US government the planet's largest mortgage finance company.

    Dozens of Banks Hurt

    Anywhere from 25 to 30 regional banks who own their preferred shares will be hurt by the Treasury plan, government banking sources say. Wall Street firms say the number is larger. Big banks including JPMorgan Chase (JPM) and Wells Fargo (WFC) could be hurt.

    Some banks could be battered hard. Losses from Fannie and Freddie preferred stock holdings at Sovereign Bancorp (SOV) could wipe out up to a year's worth of profit at the bank, analysts at CreditSights estimate.

    A research note from Keefe, Bruyette & Woods identified 38 regional banks, mostly smaller outfits, potentially hurt by the plan. Goldman Sachs says up to 40 banks and financial firms will be hurt. At least eight banks had more than 10% of their capital tied up in the shares, while another six had between 5% and 9%. It's estimated that $36 bn in preferred holdings in Fannie and Freddie sit on bank balance sheets around the country.

    The Federal Deposit Insurance Corp. now has on its watch list 117 problem banks and thrifts, the highest level since the middle of 2003. That's up from 61 in the year ago period and 90 in the first quarter. The 11th bank of the year, Silver State, failed last week. 

    The Treasury's Double Whammy 

    Many banks included Fannie's and Freddie's preferred shares' dividend stream in their profit figures, and separately, included the shares in their statutory capital cushions required by bank regulators.

    The Treasury's new rescue plan presents a double whammy to the regionals. First, it wipes out the dividends on the preferred shares in Fannie and Freddie. Second, it batters their already slammed preferred shares, which the regional banks included in regulatory capital cushions.

    Stocks in the regional banks could plunge even more, as they no longer can report the dividends in profits and as it could leave them without the required capital levels.

    Treasury Admits the Problem

    Government officials acknowledged the risks from their plans to the regionals on Sunday. "While many institutions hold common or preferred shares of these two GSEs [government-sponsored enterprises, or Fannie Mae and Freddie Mac], a limited number of smaller institutions have holdings that are significant compared to their capital," Treasury Secretary Henry Paulson said in a statement.

    The government is reportedly coming up with a plan to take care of the banks' capital shortfalls as their preferred holdings potentially get zeroed out, but so far no details have come to light.

    The Treasury did not state whether the subsequent losses at the regionals triggered by its plan would result in the takeover of troubled banks by other institutions.

    Who Gets Hurt

    Wells Fargo, (WFC), the nation's fourth-largest bank by stock market value, said it will take a third-quarter write-down on its preferred securities in Fannie Mae and Freddie Mac.

    Meredith Whitney, a widely followed banking and brokerage analyst at Oppenheimer Equity Research, estimates that Wells Fargo will report an after-tax charge in its third quarter of $281 mn to $297 mn, or 9 cents per share.

    JPMorgan Chase (JPM), the country's second largest bank in terms of assets, already said it expects to take a $600 mn loss on its preferred shares in its third quarter, half of its $1.2 bn preferred share stake in Fannie and Freddie.

    M&T Bank (MTB) owns an estimated $120 mn in Fannie's and Freddie's preferreds, Fifth Third Bancorp (FITB) owns an estimated $55 mn, and National City (NCC) owns an estimated $10 mn.

    Also vulnerable are Gateway Financial Holdings (GBTS), Midwest Banc Holdings (MBHI), Farmers Capital Bank Corp. (FFKT) and Westamerica Bancorp (WABC).

    E-Trade Financial Corp. (ETFC) and American International Group (AIG) also own preferred shares in Fannie and Freddie as well.

    Among the banks with the greatest exposure to the preferred shares of Fannie and Freddie is Sovereign Bancorp (SOV), which held $623 mn in preferred shares or about 9% of its tangible capital, according to the research firm Keefe, Bruyette & Woods.

    Sovereign recently raised $1.9 bn in capital to shore up a balance sheet battered by credit losses. "In the event that Sovereign was required to write off this entire investment, and was not able to record a tax benefit for the loss, Sovereign's capital levels would still exceed the levels required to be considered well-capitalized," the bank said in a regulatory filing.

    How the Plan Wipes out the Preferreds 

    Under the Treasury's plan, dividends on both common and preferred shares in Freddie and Fannie will be eliminated, saving about $2 bn per year. The Treasury is also buying $1 bn of senior preferred stock in each company that include a 10% dividend yield and the right to buy 79.9% of the common shares at less than $1 a share.

    Under the new regime, the preferred shareholders are second in line behind existing common shares to absorb any losses at Fannie and Freddie.

    As a result, preferred shares in Fannie and Freddie have plunged in value, as Moody's and S&P have slashed their ratings now veering towards junk status. The benchmark Freddie Mac Series Z preferreds now trade at about $2.50, and Fannie's Series S preferreds trade at around $2.04.

    Treasury's Hobson's Choice

    Letting the existing preferred shares drop in value are among the tough choices being made. Treasury's rescue plan protects Freddie and Fannie's mortgage-backed securities instead of the equity holdings in Freddie and Fannie, in order to appease central banks and commercial banks around the globe.

    The dollar amount of Fannie and Freddie's senior mortgage-backed debt obligations that the two hold on their own books now approaches about $1.5 tn.

    The two have also guaranteed about trillions of dollars in mortgage-backed securities scattered around the globe, in portfolios held by central banks and other institutions around the world. Central banks have threatened a buyer's strike unless Treasury explicitly guaranteed new issues from Fannie and Freddie, economist Edward Yardeni notes. Central banks overseas have cut their holdings in Fannie and Freddie debt securities by $18 bn sine July 15.

    According to CreditSights, the majority of US banks own sizable holdings in their mortgage-backed securities, on average about 50% of the total securities portfolio for most banks.

    That compares to the $36 bn in preferreds owned by the regionals and other banks. Zeroing out the common and the preferreds and preserving Fannie's and Freddie's debt securities was the Hobson's choice Treasury made.

    The Plan Won't Stop the Problems 

    But don't expect the really tough choice to be made-forcing Fannie and Freddie to dial back their $1.5 tn securitization portfolio, as there is little political will and resolve in Washington to do so.

    Since the two are intrinsic to the $300 bn housing bailout bill, the Treasury says it will let them temporarily expand their mortgage-backed securities holdings to $1.7 tn from about $1.5 tn. Fannie's balance sheet portfolio here is about $758 bn and Freddie's is $798 bn.

    A plank in the Treasury's bailout has it that the two companies must then cut the size of their high-risk mortgage-backed securities portfolios starting in 2010 by 10% a year, to $250 bn from $850 bn each (or to a total of $500 bn down from $1.7 tn).

    But do the math. Depending on how seriously Fannie and Freddie take this new rule--and who enforces it--it could take five to ten years to reach that $250 bn level, or even longer.

    Will a future Congress and the Treasury still have the political will to cut Fannie and Freddie down to a manageable size?

    Even Rep. Barney Frank (D-Mass.), for years an enabler of the reckless management of Fannie and Freddie, was quoted on Monday about this condition, "Good luck on that," and that it would "never happen."

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RS

This whole mess has been in the making for some time now. What better way than to gain trust by encouraging retirement savings then talk those people into investing in 401K's that could be divested by group holdings and then strip the wealth from them. Everyone needs to be a bit more realistic and look at the history of finance markets. Pretty obvious when Futures marketers bid Oil out of site everyone little investor is going to take a hit. For expert paper makers that can cook books and sell the bad paper to the FM's it is a win, win situation. If Donald Trump does not goes for Wall Street what would make one think they can and actually make good on it?

September 18, 2008 at 5:08 pm

jl

preferred stock is a popular investment for retirees to get a boost on income with relatively low risk (apparently not).FANNIE AND FREDDIE preferred were rated AA- less than 2 months ago, anyone can see this is terrible news for many retirees, people who worked their whole lives and built this country! anyone who looks closely at this bailout can see that foreign investors and big business have been protected while the little guy has been left out in the cold. btw, the reason 4-5% losses are hard on fannie and freddie is that they have $5+ trillon with a t loans outstanding, 5% of that is $250 billon. 4.5-5%default rate is probably a bit high for fannie and freddie because they do have better loans than most.

September 10, 2008 at 10:54 pm

B Scott

As an outsider(Canadian) I can see from the current comments that many Americans are confused about the US banking/economic situation.May I suggest that they turn to CNN, the unbiased,best economical/political team in the universe for answers.These guys are legends in their own minds.

September 10, 2008 at 1:50 pm

Dana Swan

The Whole Housing Bubble was caused by the elimination of the 28% rule. No home loan payment was supposed to cost more that 28% (historically) of the before tax income of the borrower, this left about 50% of their income to live on. Some how, in the last few years that grew to mortgage payments that were as high as 68% and more. This left as little as 5% of the borrower's income for them to live on after the mortqage was paid. Fannie Mae and Freddie Mac were the entities responsible for this to occur. The USA Government and the Citizens need to find out the people in those (once) private corporations and hold them accoutable for damage to the USA's economy.

September 10, 2008 at 11:26 am

anonymous

Don't worry "taxpayers" you own ALL the mortgages now. And you didn't have to pay the shareholders ANYTHING to have TOTAL control of FNM and FRE. This wasn't a takeover. In a takeover, one organization PAYS another for ownership. This wasn't a bailout. In a bailout, immediate funding is necessary to cover operations. FRE didn't need a bailout, NOW. This WAS a NATIONALIZATION. It is called SOCIALISM when the GOVERNMENT TAKES ASSETS FOR NOTHING.

September 10, 2008 at 10:40 am

DL

Can someone explain what will happen to the dividends on the preferred that was declared in August and payable on September 30, 2008?

September 10, 2008 at 10:13 am

charles0390

I seen where the senate wants the ex chiefs of freddie mac and fannie mae to take a cut in pay.Heres an even better idea,how about our lousy corrupt senators and congressmen take a pay cut instead

September 10, 2008 at 2:35 am

K. Hampton

The more I hear about the Fannie & Freddie takeovers, the more I realize what a MAJOR impact this has on the U.S. economy. I understand there weren't any options and the rescue was needed, but alot of people are getting hurt here. Has the American Dream turned into a nightmare - is the fairytale over? How did things go so wrong?

September 10, 2008 at 2:25 am

Dan Cooper

THe problem with all the financials including Etrade (ETFC) is that the federal governmnet is allowing the shorts to manipulate a companies stock and take it down to nothing in order to get a big payout. Ban all short selling on all financials.

September 9, 2008 at 11:40 pm

william mcniff

Let's get this straight the U.S. Taxpayer is now the worlds largest mortgage lender not the U.S. government. And I am one taxpayer who is not happy about this.

September 9, 2008 at 4:06 pm

Jacob Wright

>>Can you help me to understand why a mortgage foreclosure or at least 90 >>days delinquent rate of 4.5% nationwide (From Mortgage Bankers Association >>Sept 6, 2008 for end of 2nd Quarter)is causing such massive financial >>problems? It is not the current foreclosure rate, it is the present decline in value of the loan collateral (the house) and the negative effect on future default rates.

September 9, 2008 at 3:51 pm

Bill G

Hey -- LA Richard is right on. It's not just the banks that invested in these "investment grade", "low risk" preferreds, but rather many people who invested their retirement accounts in a "predictable, safe" income stream. If the government comes up with a bailout for the small (and larger) banks that took a serious hit from these preferreds, then the individual investors needs to get a class action suit going. Anyone going to political town halls -- ask your candidate if they favor punishing retirees and retirement accounts because of the mismanagement of these companies (which also had government oversight).

September 9, 2008 at 2:56 pm

david smith

Frank Elliot, It has to do with leverage. I would write the whole thing out, but go to minyanville.com and read the article "For banks, size does matter" by John Mauldin. It will explain how leverage allows for massive profits, but on the reverse, even small delinquences compound due to the leverage. It is a great article with two points to it.

September 9, 2008 at 1:58 pm

Damian

Frank, wiser people than me will need to give a better answer, but I think it is because of fractional reserves (i.e., leverage) employed by the banks. I don't want to pretend that I know the whole story, but my understanding was that even 3-5% of mortgages not being paid back and foreclosed upon meant massive losses for the banks. Search for something like mortgage-backed securities, leverage, bailout, subprime, etc. and you should find the answer.

September 9, 2008 at 1:45 pm

russ

A brief history of Reaganomics, the Mortgage Banking Crisis, and Fannie and Freddie The root of this evil was the change in rules/policies decades ago that provided mortgage guarantees to lenders to cover mortgages to home buyers who could not afford them. The standard used to be 29/36, meaning a borrower would qualify based on the lesser of the mortgage payment being 29% of their gross income or total debt to income including mortgage payment being a maximum of 36% of their gross income. We saw this creeping-up to 41%, 45%, and Fannie/Freddie even gave loan approvals over 50% if there were strong compensating factors. And Fannie and Freddie remember have been the conservative mortgage backers, there are far worse miscreants of greed at that trough. Taking these regulatory controls off the percentage of income a mortgage payment could be converted American family homes into speculative leveraged commodities. This underwriting brought on the scandalous parasitism of the grifters Freddie, Fannie, and a sick supply of banking gangsters to follow. It now becomes clear that Bonnie and Clyde were nothing compared to these bandits. They have destroyed, more than anything else, the American dream, changing it into the American scheme. Can you spell Reaganomics, may he burn in hell. This is the frightful legacy of the Reagonomics and its party. How did we get here? The recently added centerpiece in this story is the United States government allowed, nay intentionally inflated an $8 trillion unchecked housing bubble. Between 1996 and 2006, house prices rose by more than 70 percent, after adjusting for inflation. In the previous century, from 1896 to 1996, house prices had just kept even with the overall rate of inflation. While partying loyalists may grimace at their hero’s fall it is neither intellectually nor historically dishonest to blame Godfather Reganomics and family and deregulation for throwing the chum, or rather chumps, in the water to attract the sharks. The feeding frenzy Reaganomics created surely expanded far beyond Fannie and Freddie and FHA as was the intent of the so called "leadership." As history teaches us it frequently takes a long time for such cleverly designed crimes against society to run a course and come to light. And as this case illustrates it helps to have the crooks take over control of the executive to allow the completion of the last 8 years of the topping on the cake. This America and our society ought not to be conformed into a sporting event! Team (or party) spirit complete with cheerleaders in place of intelligent good and honest intentions is what the grifters bank on. The trillion squandered on the Iraq fiasco was our collective nest egg for the long predicted hard times and rainy days we are just now beginning suffer. Unemployment is at a 50 year high and foreclosures are at the highest level for since Bonzo days. The fact that the broad ranging economic collapse we all now face is clearly one of the effects of converting the American dream into the American scheme. Common dreams for the common good are what this great country was and is built upon and it is high time to take back those dreams from those who perverted them to their dastardly greed. FOX might consider its love of country and its duty to put some real historical perspective in front of its readers.

September 9, 2008 at 1:36 pm

Frank Elliott

Can you help me to understand why a mortgage foreclosure or at least 90 days delinquent rate of 4.5% nationwide (From Mortgage Bankers Association Sept 6, 2008 for end of 2nd Quarter)is causing such massive financial problems? It seems to me that there must be many pools of mortgages which are doing well such as those outside the subprime adjustable rate group. Over 95% of mortgages are not seriously delinquent. I understand that this rate of 4.5% is a huge increase from the historic rate -- probably less than 1%. Is this because some institutions are heavily invested in non-performing loans? I don't understand either why Fannie Mae and Freddie Mac have had to be rescued. It would seem to me that the vast majority of their loans must be sound given that over 95% of mortgages are relatively current. Is this because large institutions and investors are refusing to invest much if anything in securitized loans? I'm also thinking that the reserves set aside by many institutions must be relatively low. To me as an individual investor, I am able to handle 5% of my portfolio going bad. So, I just don't understand very well what chain of events the 4.5% of loans which are bad sets up. I appreciate any help you can give me in understanding better what's causing the major dislocations in our mortgage markets. I do understand that a much larger percentage of subprime loans are seriously delinquent or in foreclosure. Thanks so much.

September 9, 2008 at 12:41 pm

John D. Froelich

Here is another great example of government intervention in the markets that has gone awry! The bright side is that the extreme expense makes health care by government less likely.

September 9, 2008 at 12:32 pm

Dan Cooper

I was concerned with Etrade (ETFC) owning fannie and freddie and I emailed Etrades investment line and they stated that Etrade Liquidated all its investment with fannie and freddie July 31st. In that Email they also reiterated that they Q2 results specified that they were elminateing this investment due to a potential government bailout. Fell free to view Etrade Q2 report and in addition Emial their investment line.

September 9, 2008 at 12:24 pm

Stan Steenhuis

They made an investment that traded profit for risk. Some investments lose money. Grow up.

September 9, 2008 at 12:04 pm

Chris H

I'm confused.. This plan was to help who? Ladies and Gentlemen it is my belief that we haven't seen anything yet. Dim the lights and get you rose colored glasses because the party is just getting started!

September 9, 2008 at 12:04 pm

L.A. Richard

As the Bush Administration takes over Fannie Mae and Freddie Mac, please keep in mind that many many "regular folks" that are on retirement incomes and many more that will be retiring are relying on the preferred share dividends of Fannie and Freddie. They are both American institutions that have represented higher quality mortgages, not sub-primes...as required by our government's rules and the oversight of both of the mortgage giants. The preferred shares were not high risk "junk" stocks. They were purchased by many retirement plans banks and individuals with 401's and other retirement plans as a means to both fund the country's mortgage system and ensure stable income for their retirement years. The media keeps projecting that "greedy investors" and "rich" investors would lose money. I am a retiree and I wonder how many retirement incomes will be devastated by this move and the elimination of dividends. How many folks will have problems covering their own mortgages as their incomes and investment savings collapse as the Freddie and Fannie shares drop to nothing? Anothr short-sighted move by the administration. Who will NOW be willing to fund anything Freddie and Fannie put forth? Who will now provide funds for the backbone of the country's martgage system? Don't punish Americans who invested their future in our own country instead of high return emerging markets and foreign stocks. Regards, *** LARichard ***

September 9, 2008 at 11:55 am

El Macho Porteño

That's the way it always works... banks risk every asset for one more penny, it happened many times, it will continue happening in the distant future.

September 9, 2008 at 11:37 am

Washington

"All your house are belong to us" Sincerely, Your federal government

September 9, 2008 at 11:29 am

about this blog

  • Elizabeth MacDonald is the stocks editor for Fox Business Network. She is recognized as one of the top prize-winning business journalists in the country, and has received 14 awards, including the top prize in business journalism, the Gerald Loeb Award for Distinguished Business Journalism, and the Newswomen's Club of New York Front Page Award for Excellence in Investigative Journalism.

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