Fannie Mae 'AAA/A-1+' Sr. Debt Rating Affirmed; Other Ratings Lowered, On CreditWatch Negative

NEW YORK, Aug. 26, 2008--Standard & Poor's Ratings Services said today that it affirmed its 'AAA/A-1+' senior unsecured debt rating on Fannie Mae with a stable outlook.

At the same time, we lowered our risk-to-the-government stand-alone issuer credit rating on Fannie Mae to 'A-' from 'A', the subordinated debt rating to 'BBB+' from 'A-', and the preferred stock rating to 'BBB-' from 'A-'.

All the ratings we lowered are also placed on CreditWatch Negative.

"The affirmation of the long-term 'AAA' and short-term 'A-1+' senior unsecured debt ratings reflect our expectation of continued government support for the viability of Fannie Mae and its senior unsecured debt, as represented in the Treasury's Economic Stimulus Plan released earlier this year," said Standard & Poor's credit analyst Victoria Wagner. (top left photo)

The government-sponsored enterprises' mortgage franchises are viable and critical to the financing of the U.S. mortgage market and the overall economy.

(Federal Reserve Bank, Washington, DC, at left)

The downgrade and placement on CreditWatch Negative of the subordinated debt and preferred stock ratings reflects increasing uncertainty about whether government support will extend to these securities in the context of further deterioration in the asset quality of Fannie Mae's mortgage portfolio.

The risk-to-the-government rating was lowered and placed on CreditWatch Negative because of the expected higher stress on capital and earnings Fannie Mae faces over the next several quarters.

The long duration of the weak housing market and the rising severity of residential mortgage losses are driving credit costs higher and Fannie Mae's operating earnings lower.

The majority of credit-related losses to date have been from its exposure to Alt-A mortgages, which amounts to 11% of its total single-family mortgage book.

Standard & Poor's expects peak mortgage losses to occur in 2009 to a level that could require further capital raising to maintain the cushion above the regulatory requirements.

In addition to the weak mortgage credit cycle, Fannie Mae is facing ever more challenging market conditions to raise cost-effective capital. The depressed market pricing of its common and preferred securities and the uncertainty about Treasury's financial assistance has created an even more challenging operating environment, significantly inhibiting Fannie Mae's financial flexibility.

The recently passed Housing and Economic Recovery Act of 2008 (Public Law 110-289) has reinforced expectations that the government will act to prevent default on Fannie Mae's senior debt obligations, but has also led to great speculation in the financial markets about if and how the U.S. Treasury will act and what will be the related consequences for subordinated debt and preferred stockholders.

Treasury has several options authorized under Public Law 110-289. These include the following: buying Fannie Mae's debt or its agency mortgage-backed securities; providing an explicit guarantee for its debt; or putting forward an equity investment. An equity investment by Treasury may be accompanied by the consideration of nonpayment of existing preferred and common dividends.

The subordinated notes pose incremental risk to investors because of an interest deferral feature given certain trigger events tied to Fannie Mae's regulatory capital levels.

The subordinated debt covenant language also states that a deferral of the subordinated debt interest payment triggers the nonpayment of all preferred and common stock dividends.

This feature argues for a close alignment of preferred stock and subordinated debt ratings. However, we now rate the preferred stock two notches below subordinated debt to reflect the increased risk of nonpayment of dividends as a means of capital preservation.

Furthermore, there are no covenants restricting the payment of interest on the subordinated debentures, while the preferred dividends are suspended. Fannie Mae's nonsenior debt and risk-to-the-government ratings will remain on CreditWatch Negative until Treasury's intentions are clarified.

Media Contact: Jeff Sexton, New York, (1) 212-438-3448 jeff_sexton@standardandpoors.com
Analyst Contacts:
Victoria Wagner, New York (1) 212-438-7406
Daniel E Teclaw, New York (1) 212-438-8716