As investors are increasingly interested in the creditworthiness of the government-sponsored enterprises, Moody's Investors Service is cautioning the buyside to remember that not all GSEs are created equal.

In a recently released report, the rating agency says that there are three main reasons for this growing interest in the agencies' credit histories. The first is the credit spread volatility that resulted from past GSE financial problems, particularly with Fannie Mae's asset quality problems in the early 1980s and the Farm Credit System's weak asset quality in the late 1980s and early 1990s.

The second is the continued expansion of the GSEs' borrowing volume into overseas markets, especially the Euromarket. And thirdly, the report mentioned the GSEs' use of derivatives to facilitate asset-liability management.

But the report also stated that each GSE must be evaluated on its own set of criteria, since the agencies are significantly different from one another.

"People often think of GSEs as a homogenous group, which is simply not the case," said John Kriz, managing director for real estate finance at Moody's. "People are doing themselves and their clients a disservice if they aren't taking proper recognition of these services," which include their capital structures, financial results and relationships with the U.S. Government.

Moreover, Kriz points out that it is a misconception to believe that all GSEs are rated triple-A. For example, the domestic currency of the National Consumer Cooperative Bank is rated Baa1, while the noncumulative preferred stock of Fannie Mae and Freddie Mac is Aa3.

"We have variance depending on where you are in the capital structure," he said. "So the point we want to make is changes occur to GSEs and simply assuming that all obligations are almost by definition triple-A is just not the case."

What Does This Mean?

The report's conclusion regarding Fannie Mae was that the agency's rating should remain stable and that government support will continue, despite the fact that the company does not have a triple-A credit rating.

"Liquidity and capital are adequate given Fannie Mae's GSE status, and interest rate and credit risks are effectively managed," the report stated. "Asset quality is healthy, and Fannie Mae benefits from its conservative underwriting and diverse portfolio." A representative from Fannie Mae was not able to comment by press time.

Freddie Mac received a similar analysis: "The moral obligation of the U.S. Government to assist in periods of stress is reinforced by Freddie Mac's dominant position in U.S. housing finance and by the broad ownership of its securities by U.S. banks, thrifts, pension funds and foreign investors. Earnings growth has been consistent, liquidity and capital are adequate given Freddie Mac's GSE status, and interest rate risks are being effectively managed." Moody's officials also believe that Freddie Mac's ratings are not expected to change over the medium term.

"We think that Freddie Mac's credit is without question, and we stand by that," said Douglas Robinson, a spokesman for Freddie Mac.

Because the analysis of the GSEs is complex, each GSE was analyzed on different criteria. However, two main facets of the agencies were used in determining the credit ratings.

The first was Moody's analysis of the GSE when considered as a business, and the second criterion was the relationship the company has with the government. However, Kriz noted that even those relationships vary on a case-by-case basis.

Other criteria included the political prominence of the GSE, as well as its success in fulfilling the policy mandated by the U.S. Government.

"These are complex businesses with complex credit stories and you have to do your homework as you would for anyone else, and you may be lulled into wrong conclusions unless you do your homework," Kriz said. "You have to look at all these issues in order to come to a conclusion, and that's a complex undertaking. That's one of the points we're trying to make."

The Privatization Question

With the past privatization of Conrail and the future privatization of Sallie Mae Corp., a question rises as to whether to expect future privatization of any remaining GSEs. Moody's' report says that is not likely in the near future.

"Our conclusion is that for the GSEs we rate, Moody's does not believe that any of the GSEs we now rate is likely to be privatized in the medium term," Kriz said. "And so we don't see privatization as a political agenda item for the medium term."

Freddie Mac's Robinson said that privatization is in the hands of Congress, not with the GSE itself. "Congress would be the one who would do something like that," he said. "We already have public stockholders, so I don't know why the word privatization' is used around Freddie Mac when we have a government-sponsored enterprise charter. Freddie Mac's mission is clear, and adheres to its mission vigorously everyday."

In conclusion, the Moody's report reaffirmed its GSE ratings, and stated that privatization of future GSEs is not on top of the list, but that "privatizations do happen, and GSE defaults have occurred around the world, including the United States," Kriz said. "[The report is] an illustration of the fact that GSEs are complex credits and can contain significant amounts of risk. Often folks hear the term GSE' and figure, Well, it's a high rating and it's not a problem.' One would be incorrect to assume all those things."

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