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On Tuesday, Standard & Poor’s (S&P) upgraded the subordinated debt ratings on Fannie Mae (FNMA) and Freddie Mac (FMCC) by two notches to AA- from A. The upgrade was driven by government support in relieving debt of these two agencies over the last five years, along with affirmation of continuation of the same in the coming period.

However, Standard & Poor’s affirmed AA+/A-1+ long- and short-term senior unsecured debt ratings and D ratings on the preferred debt of the two agencies. Further, the ‘Stable’ rating outlook on the senior unsecured and subordinated debt remained unchanged.

Background Details

To ensure U.S. housing financial market stability, in Sep 2008, Fannie Mae and Freddie Mac was taken over by the government. The federal takeover entailed the placing of these two government sponsored enterprises (GSEs) under the U.S. Treasury.

These two firms incurred losses of $14.9 billion during the financial crisis. Therefore, to keep these GSEs operating, the U.S. Treasury and Federal Housing Finance Agency (FHFA) provided support for both senior and subordinated debt, along with agency mortgage-backed securities. Further, the Treasury suspended the subordinated debt's interest-deferral agreement and consequently paid continuous interest on the instruments despite the agencies' weakening financial position.

Notably, till date, full principal and interest of the subordinated debt continues to be paid. However, the remaining subordinated debt outstanding at both Fannie Mae and Freddie Mac will mature earliest by 2019.

Similar Action

Last month, following its review of 8 major U.S banks, Moody's Investors Service, the credit rating arm of Moody's Corp. (MCO - Analyst Report) lowered the senior holding company ratings of Morgan Stanley (MS - Analyst Report), The Goldman Sachs Group, Inc., JPMorgan and The Bank of New York Mellon Corporation. The ratings downgrade reflects the credit rating body’s belief of there being less chances of the U.S. government bailing out financial institutions in the case of a future financial crisis.

On the other hand, Moody’s affirmed the senior holding company ratings of 4 other banks, namely Bank of America Corp., Citigroup Inc., State Street Corp. and Wells Fargo & Co. We believe that the reiteration of ratings reflect these banks’ improved capital position for the quarter ended Sep 30.

Conclusion

The rating upgrades are valuable as they play a major role in boosting creditworthiness in the market. However, S&P might consider lowering the ratings depending on the degree of government support received by the GSEs in the coming period. Currently, Fannie Mae and Freddie Mac carry a Zacks Rank #2 (Buy).

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