In a conference call and a report entitled GSEs: Are the AAA' Ratings at Risk? Fitch Ratings analysts said that, at present, there are no threats to Fannie Mae's and Freddie Mac's triple-A senior debt ratings despite these agencies' accounting woes and the headline risk that currently surrounds them.
In the report, Fitch analysts stated that both GSEs "possess characteristics that minimize the probability of default and therefore warrant the assignment of very high credit ratings." These characteristics include limited credit and interest rate risk appetite, quality of systems used to measure and manage interest rate and credit risk and significant funding advantages. The senior debt ratings also assume U.S. government support in the event of severe financial stress, said Fitch.
However, Fitch does not extend the same treatment to Fannie's and Freddie's subordinated and preferred obligations ratings. In fact, the misapplication of FAS 133 and other standards of U.S. GAAP and operational issues have caused the downgrade of Freddie Mac's subordinated debt and preferred stock ratings to AA-' and remain on Rating Watch Negative. Meanwhile, accounting issues and capital concerns caused the downgrade of Fannie's subordinated debt rating to AA-' and its preferred stock rating to A+'. These all remain on Rating Watch Negative.
Fitch also noted that, despite Federal Reserve Chairman Alan Greenspan's recent rather critical comments on the GSEs, there has not been any formal and widely supported legislative proposal endorsing the removal of the U.S. government's implicit support of the two agencies, adding that all variations of legislative proposals thus far have focused on strengthening regulatory oversight and not on changing the mission or charter of either Fannie or Freddie. "Fitch believes that a strong regulator is paramount to ensuring the safety and soundness of the enterprises and Fitch would respond favorably to legislation that creates a strong regulatory framework," said the report. On the accompanying conference call, Fitch analysts said that even if the government's implicit support were removed, this would occur as a gradual process, similar to what happened in the case of student loan lender Sallie Mae, now rated single-A.
"Fitch believes any formal separation would have to occur subsequent to a return to normal financial reporting and steady state operations for both Fannie Mae and Freddie Mac," Fitch analysts wrote. "Therefore, such proposals are unlikely to emerge in the current debate." Aside from this, the concept of support is based on several factors that are systemic including the U.S. government charter, GSE size and stature in the global markets and Congress' public policy objective enhancing U.S. home ownership.
Fitch analysts said that they would be focusing more on the implementation of any proposed legislation and the subsequent effect on the GSEs, rather than the actual legislation - although analysts did note that they would likely respond more favorably to legislation having a more "rigorous checks and balances' framework than is currently proposed." They also said that assuming legislation is enacted, Fitch will be monitoring factors such as the role and influence of the regulator, the GSEs' risk management framework, mission changes affecting these agencies' risk profile, changes in funding costs or market access and capital management initiatives ensuring the compliance with regulatory capital requirements and the maintenance of an acceptable leverage profile.
In the conference call, analysts also discussed the news last week that OFHEO had discovered a new set of potential accounting violations at Fannie Mae that once again raised safety and soundness concerns. Rating analysts said that principles of accounting have changed over time as there has been a movement towards mark-to-market accounting, affecting how Fannie's financials are viewed. However, analysts said that since the GSE's mortgage assets have maintained their fair value over time, this is an indication that there has been no economic loss involved. Also, Fitch analysts mentioned that Fannie shares additional nonpublic operational information to them that gives them comfort in terms of the agency's accounting practices and derivatives exposure.
Fannie and Freddie ratings would not likely be affected by the removal of the Treasury line of credit. "Given the debt levels outstanding, the credit lines are more symbolic than economically significant," analysts wrote.
Analysts also mentioned that proposed changes to accounting systems enhancements would not change the risk measurement systems of either GSE, stating that both firms are still providing interest and credit risk-based measures that are well within the rating agency's expectations. "The interest rate risk posture of Fannie Mae has been materially reduced over the last year after investor concerns in the fall of 2002 and in response to issues at Freddie Mac," analysts wrote. "Fitch believes these institutions have capable industry experts assessing the prepayment and credit risk of the mortgages they hold in portfolio."
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