Fitch’s recent lowering of Fannie Mae and Freddie Mac credit ratings following an earlier U.S. downgrade highlights some considerations related to whether they should eventually be removed from conservatorship.
For one, as much as the downgrades may not reflect well on the public ties the government-sponsored enterprises have, the rating actions suggest those links still beat the alternative for the GSEs.
“The implicit government support is still the driver of the ratings, and the GSEs would be rated lower without it,” said Eric Orenstein, senior director in Fitch’s nonbank financial institutions group.
So while the earlier lowering of a U.S. sovereign rating did hurt Fannie and Freddie’s equivalents for long-term issuer default, senior unsecured debt and government support, their public ties are still considered a relative positive.
That dichotomy is in line with the fact Fannie and Freddie’s mortgage-backed securities aren’t normally rated because of their government-related support, fueling debate about the extent to which downgrades influence a bond market that drives borrowing costs.
“There’s really not an official rating for the MBS, so the assumed rating is whatever the Treasury is rated,” said Walt Schmidt, senior vice president, mortgage strategies, at FHN Financial. “From that standpoint, I don’t think this has a direct effect.”
And while Fitch said the U.S. has seen “a steady deterioration in standards of governance over the last 20 years, including on fiscal and debt matters,” Freddie and Fannie’s financials are strong, suggesting they’re not immediate taxpayer risks.
Fitch confirmed it “does not rate any MBS products directly issued by the GSEs.” If they did, those securities would theoretically have a rating that matched Fannie and Freddie’s long-term IDR.
However, the credit risk transfer securities the GSEs use to sell off some of their risk to private-label investors based on reference pools of their loans do get rated. Fitch lowered the ratings of 435 of these. Only those with top ratings were impacted.
Fitch groups Fannie and Freddie’s CRTs with non-agency residential mortgage-backed securities, but otherwise securitization ratings that it considers to be part of the private market weren’t affected.
While some GSE and United States ratings are now one-notch down from the highest possible grade, they have generally remained at the upper end of the scale. Also, Fannie and Freddie’s short-term issuer default rating remained unchanged at the highest rating. (In addition to Fannie and Freddie, Fitch also had downgraded the Federal Home Loan Banks of Atlanta and Des Moines at press time.)
Fitch’s downgrade of Fannie is “not being driven by fundamental credit, capital, or liquidity deterioration,” the GSE said in an emailed statement sent in response to inquiries about the rating actions, echoing some of the wording Fitch used to describe both enterprises.
Fannie and Freddie’s regulator, the Federal Housing Finance Agency, issued a similar statement, while adding that, “As no one can predict future outcomes, FHFA is carefully watching the ratings downgrade to assess its impact on the MBS markets and the GSEs.”
There has been disagreement among rating agencies related to U.S. sovereign rating. Kroll Bond Rating Agency and Moody’s Investors Service, in contrast to Fitch, reaffirmed top ratings for the United States on Thursday.
But while disagreement among rating agencies and other aforementioned factors do blunt the impact of the Fitch downgrades on the mortgage market, it may not be entirely immune to them.
There might be an impact on Fannie and Freddie’s unsecured debt in particular given the change in that rating and the fact that they’re more reliant on it because those bonds are not backed with mortgage collateral the way agency MBS are.
And while there’s some disagreement on this point, even agency MBS could be at least peripherally affected by the downgrades in ways that could put upward pressure on financing costs, depending on whether other rate drivers outweigh them.
“I think there is an indirect effect in the whole downgrade story. It perhaps has contributed to slightly higher yields, but there are a lot of cross currents in the market,” Schmidt said.
Bonnie Sinnock
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