Ten Banks That Will Be Hurt By the FNM and FRE Government Takeover

The government takeover of Fannie Mae (FNM) and Feddie Mac (FRE) should be a positive for most banks.  The deal will lower mortgage rates and will also allow the Treasury Department to purchase mortgage-backed securities from firms in the open market.  That will allow a lot of mortgage paper that is currently clogging the system to start moving again.  However, several banks will be hurt by the bailout of FNM and FRE because they own a considerable amount of FNM and FRE preferred equity relative to their capital bases. 

According to my math, the government will essentially own about 80% of FNM and FRE after the bailout.   The current preferred equity will no long pay a dividend until at least 2010.  While the preferreds have traded 45% to 65% lower already, they will most likely be completely wiped out from here.  If the companies can recover, there might be some value to the common and preferred equity in five to ten years.  However, as the companies enter run-off, my guess is that the common and preferred equity will not regain much value. 

Some banks such as Valley Financial (VLY) have already announced that they will take a charge for the decline in the value of their FNM and FRE preferred equity. 

In the second quarter of 2008, Valley National Bancorp ("Valley") disclosed that it holds Fannie Mae and Freddie Mac perpetual preferred stock with a cost basis of approximately $79 million. Such securities are held in Valley's available for sale securities portfolio and as such are subject to a potential other than temporary impairment charge. The estimated fair market value of these securities has declined from June 30, 2008 by approximately $40 million as of September 2, 2008, which if recognized would result in a $25.7 million after-tax impairment loss, or approximately $0.19 per fully diluted average common share for the third quarter of 2008. Valley sold a small portion of these securities during the third quarter, bringing its current adjusted cost basis in such securities to approximately $70 million. The aggregate amount of losses and other than temporary impairment that may be incurred on these securities during the third quarter of 2008 is difficult to determine, given the low trading volumes and the significant volatility in the market values of these securities. Based on management's current projections, a potential other than temporary impairment and loss on these securities would not impact its subsidiary bank's (Valley National Bank) ability to maintain capital ratios above the "well capitalized" regulatory requirement, or Valley's ability to pay its regular quarterly cash dividend to common shareholders.

Five banks have significant exposure to Government Sponsored Enterprise (GSE) equity that it could impact their capital ratios and force them to raise additional capital, according to Friedman Billings Ramsey's research.  The percentages in parentheses represents the percent of tangible capital is held in GSE preferred equity. 

The top five exposures in our dataset by this metric were Gateway Financial Holdings (GBTS 8.1%), Midwest Banc Holdings (MBHI 26.3%), Financial Institutions, Inc (FISI 15.0%, based on securities collateralized by GSE preferreds), Westamerica Bancorporation (WABC 10.6%), and Sovereign Bancorp (SOV 8.9%). We have used an estimated after-tax exposure (using an assumed tax rate of 35% for all companies, for simplicity) in this analysis to improve the transparency of the relationships of these exposures to bank and thrift equity and capital, as unrealized gains or losses in these securities would only affect equity on an after-tax basis.

The next five banks on the list could also find themselves in need of additional capital after writing down the value of their GSE Equity exposure.  Flushing Financial Corp (FFIC - 7.5%), Valley National Bancorp (VLY - 6.5%), Astoria Financial Corporation (AF - 4.8%), East West Bancorp (EWBC - 4.1%) and Washington Federal (WFSL - 3.6%).

The full list of banks with material exposure to GSE preferred equity is listed below.  All data comes courtesy Friedman Billings Ramsey. 

  Source: Friedman, Billings, & Ramsey & Co.

So while the majority of banks and financial stocks should rally on this news, several banks could be seriously hurt and even trade significantly lower. 

Comments

[Contrahour]

Not sure what it means for the banks in question...

FDIC to help small banks with Fannie, Freddie exposure

Last update: 12:43 p.m. EDT Sept. 7
By Michael R. Crittenden
Of DOW JONES NEWSWIRES
WASHINGTON (Dow Jones)--U.S. banking regulators said Sunday they will work with banks whose holdings of Fannie Mae and Freddie Mac securities could be adversely affected by the federal government's takeover of the two firms over the weekend.
"Any negative impact will be narrowly focused only on a few smaller institutions. Regulators will be working closely with those few banks to develop capital plans to assist their recovery," Federal Deposit Insurance Corp. Chairwoman Sheila Bair said in a statement.
The Treasury Department and Federal Housing Finance Agency jointly announced a takeover of the firms Sunday morning, along with a number of lending and investment plans to be made through Treasury to shore up the two troubled mortgage-finance firms. The plan includes Treasury purchasing mortgage-backed securities in the firms, as well as a senior preferred stock purchase agreement starting at $1 billion with each firm.
Placing the two firms into conservatorship under the FHFA means holders of the firms' common stock and outstanding preferred stock will be first in line to absorb any future losses at the companies. Some of the holders of these securities are banks, and Treasury Secretary Henry Paulson said regulators will be evaluating the affect of their moves on various institutions.
"The agencies encourage depository institutions to contact their primary federal regulator if they believe that losses on their holdings of Fannie Mae or Freddie Mac...are likely to reduce their regulatory capital below 'well capitalized'," Paulson said. "The banking agencies are prepared to work with the affected institutions to develop capital restoration plans consistent with the capital regulations."
A joint release from the FDIC, Federal Reserve, Office of Thrift Supervision, and Office of the Comptroller of the Currency said that only a limited number of banks have GSE holdings that are significant compared to their capital. The agencies also gave firms guidance on how to account for the holdings.
"All institutions are reminded that investments in preferred stock and common stock with readily determinable fair value should be reported as available-for-sale equity security holdings, and that any net unrealized losses on these securities are deducted from regulatory capital," the joint release from the regulators said.

[market folly]

good finds, thanks for the info