GSE subordinated debt gains, preferreds lose

By Al Yoon - Analysis

NEW YORK (Reuters) - The preferred stock and subordinated debt of Fannie Mae and Freddie Mac diverged sharply in price on Monday after the government drew a clear line in the sand between the securities that many investors thought carried similar risks.

The preferred shares lost more than 80 percent of their value after the government seized control of the two mortgage finance companies in a conservatorship on Sunday, creating a new class of senior preferreds for itself and eliminating dividends on outstanding issues indefinitely.

To the surprise of many, subordinated debt issues, meant to be indicators of the risks taken by the companies, emerged unscathed from the restructuring with their interest payments intact. Yield spread premiums on Fannie Mae subordinated debt maturing in 2011 plunged by three percentage points to a bid of 3.50 points, creating an instant windfall, with apparent momentum, for holders.

Investors over the past 24 hours have been scouring U.S. Treasury Department and Federal Housing Finance Agency comments for any sign that their preferred shares could see any recovery. But details from the Treasury suggest the companies will hold the dividends as long as the conservatorship lasts.

With a U.S. presidential election due in November, some investors wondered if there was a ray of hope for Fannie Mae and Freddie Mac who have used their power over the U.S. housing market to foster deep political ties. But the huge structural change underway at the government-sponsored enterprises (GSEs) will be hard to stop, analysts said.

"Once we crossed the rubicon of doing what Treasury and FHFA have done, it would take something substantial for the new administration to reverse some of this," Scott Peng, a rate strategist at Citigroup said on a conference call on Monday.

Peng said that Citigroup did not expect the move by Treasury, and that there was no sense of urgency. Citi equity analyst Bradley Ball was one of many Wall Street analysts in recent weeks that said the companies had enough capital to operate at least into 2009.

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