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DEUTSCH & LIPNER
FNM and FRE Preferred Stock In December, 2007, Fannie Mae issued series S 8.25% preferred stock; at about the same time, Freddie Mac issued series Z 8.375% preferred stock. Major brokerages such as UBS and Citigroup/SmithBarney aggressively recommended that their fixed-income clients buy these securities. Lots of these investors already owned Fannie or Freddie bonds, and some of that debt was being redeemed at about this time, so the investors had cash. Our investigations have revealed that many of these investors were advised to buy this Fannie Mae and/or Freddie Mac preferred stock. Such a switch is a significant increase in risk. Any switch from debt securities to preferred stock, with the latter’s lower priority and reliability, creates an increase risk, but in this situation that increased risk was greatly compounded by the riskiness of investing in Fannie Mae or Freddie Mac at that very time. By Summer of 2007, the problems in the sub-prime and Alt-A mortgage market had become public. By the end of 2007, financial firms with exposure to the mortgage market, such as Freddie Mac and Fannie Mae, were already being hit hard. A report from FNMA dated Nov 9, 2007 shows, inter alia, that the Fannie Mae loan portfolio contained over $400 billion in sub-prime and Alt-A mortgages, that these mortgages constituted 1/6 the total mortgages held by Fannie Mae, and that default rates were rising. These problems were starting to manifest themselves on the bottom line. Earnings at Fannie Mae went from a profit of $3.65 per share in 2006 to a loss of $2.63 in 2007. Similarly, Freddie Mac’s earnings fell from $3.00 in 2006 to a loss of $5.37 per share in 2007. Indeed, that was the first loss reported by FNM and FRE over the last 5 years:
Annual Earnings per share for FNM and FRE 2003-2007 Both these firms had been forced to take enormous write-downs in 2007, and their capital levels were severely depleted. Fannie Mae and Freddie Mac responded to that depletion by issuing unprecedented amounts of (new) preferred stock in 2007. In 2007, Freddie Mac issued $8.6 billion in preferred stock. By contrast, it had issued only $1.5 billion in preferred in 2006, and none at all in 2005. Similarly, Fannie Mae issued $7.8 billion in preferred stock in 2007. These new offerings represented more than 20% of the total stockholders’ equity in FNMA as of the end of the year 2007. Fannie Mae and Freddie Mac had run out of money to lend, and the issuance of these large quantities of preferred stock was needed to keep them (precariously) afloat. But losses were continuing and they were mounting, and the firms’ ability even to pay the dividend on the preferred stock was already in doubt. This was no time to start buying the junior securities of these troubled companies. These warning signs should have been apparent to the investment professionals, but these signs seem to have been (negligently) ignored by the brokerages. These firms recommended buying the preferred stock of Fannie Mae and Freddie Mac without disclosing that these firms were up to their ears in then-public, and growing, sub-prime mess. These brokerages and banks appear to have been as blind to the risk in Fannie Freddie as they were inept at managing risk in their own portfolios. No wonder we’re in the mess we’re in!!!
When Fannie and Freddie were taken over by the government, the preferred
shareholders were wiped out. If your advisor recommended that you buy
Fannie or Freddie preferred stock in 2008, we may be able to help you
recover your losses. Call for a free consultation. |
