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Preferred Backlash to GSE Bailout Grows

Holders of preferred equity in both Fannie Mae (FNM) and Freddie Mac (FRE) aren't likely to take the Treasury's weekend move to place both mortgage finance giants into conservatorship lying down, sources suggested to HW on Thursday. The move has roiled preferred securities on both GSEs, as well as other preferred equities as well. Numerous holders of both preferred and common stock interests in the GSEs have been issuing press statements regarding their exposure and impact on capital, including many community banks. New England-based LSB Corp. (LSBX), a holding company for community banking operation River Bank, said Thursday that it held $10.1 million in Fannie/Freddie preferreds at the end of June; those holdings had declined in fair value to $6.4 million by Aug. 11, the bank said. By Sept. 9, the bank had marked its holdings to $1.1 million. The preferred hit will bring River Bank's regulatory total capital ratio down from a reported 13.3 percent to an estimated 10.8 percent, the company said; regulatory guidelines require at least a 10 percent ratio to maintain a "well capitalized" classification. The company had been repurchasing shares, but said it will suspend its stock repurchases "until further notice." Things are considerably worse at Gateway Financial Holdings, Inc. (GTBS), the parent company of Gateway Bank & Trust Co., a regional bank operating primarily in Virginia. The company said Thursday it also held a significant amount of preferred equity in the GSEs, but that it would need to raise capital to remain "well capitalized" under regulatory standards. The company said its preferred holdings in each GSE were marked at a cost of $20.2 million and $20.2 million, respectively, and that its preferred holdings were currently trading at five to 10 percent of par value. The company said it would look to raise capital via a stock offering before the end of Q3. Not just small community and regional banks Of course, more than just community and regional banks have bit hit by the de facto nationalization of the GSEs; as HW reported earlier this week, Wells Fargo & Co. (WFC) will take a hit on $480 million of preferreds when it reports Q3 results. Beyond Wells Fargo, other commercial banks are feeling the sting, as well. Citigroup Inc. (C) said in a filing with the Securities and Exchange Commission Wednesday that it has taken a $450 million hit so far this quarter on its preferred holdings, as the Fannie/Freddie securities have fallen roughly 95 percent in value. Bank of America Corp. (BAC) global corporate and investment bank chief Brian Moynihan told attendees at a conference in New York sponsored by Lehman Brothers Holdings Inc. (LEH) that the bank will take a hit in Q3 from its preferred holdings, but did not specify details. The smartest bank on the block? That would be Wachovia Corp. (WB), which said Tuesday in a regulatory filing of its own that it had liquidated its $509 million of GSE preferreds at a pretax loss of $171 million, completing the sales on July 21. (To which we say that either new CEO Richard Steel is a prescient man, or his relationship with Treasury secretary Hank Paulson is paying some real dividends....) Beyond banks, insurers are feeling the strain as well. Rating agency A.M. Best has estimated that insurers hold roughly $4 billion in preferred securities at both GSEs. On Wednesday, The Travelers Cos. (TRV), the second-largest U.S. commercial insurer, disclosed that it held $7 million in preferred equity in one or both GSEs. Company CEO Jay Fishman announced the holdings in the same New York conference as BofA. The world's largest insurer, American International Group Inc. (AIG), may have considerably more to lose. Citing a source close to the company, Reuters reported Thursday that AIG has $600 million in Fannie/Freddie preferred securities. That number is considerably less than some investors had feared in recent days. And title insurance giant the First American Company (FAF) said Tuesday that it held $37.9 million in GSE preferreds, as well. Reuters reported earlier this week on an estimate by Standard & Poor's which said that U.S. and European banks hold roughly $5 billion in preferred equity at both GSEs. "I don’t know what’s going to happen, but the [preferred equity] backlash could grow bigger than Washington thinks," one analyst told HW, on condition of anonymity. "Stay tuned." In the meantime, BusinessWeek ran a good piece on just how big the preferred share fallout may really be. Bloomberg noted that the entire market for preferred securities has been roiled by the fallout at the GSEs, with prices registering their largest one-day drop in a decade on Sept. 8. Disclosure: The author held no relevant positions when this story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.

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