Relief for bondholders, but investors in Fannie and Freddie prepare for the worst

he holders of more than $8,000 billion (£4,500 billion) of US mortgage bonds avoided potentially huge losses yesterday as the American Government threw its weight behind securities insurers such as Freddie Mac and Fannie Mae, that guarantee the interest payments on those bonds.

By contrast, shareholders in Freddie and Fannie are expected to be hammered today amid concerns that the Government’s plan to inject cash into the two groups, in return for newly issued stock, will virtually wipe out their holdings.

The value of the $5,400 billion of mortgage bonds that Fannie and Freddie guarantee, which represent the largest chunk of nongovernment debt in the world, is largely determined by their perceived ability to honour the guarantees on these securities in the event of a default on the underlying home loans. These bonds are owned by big financial institutions and central banks around the world.

The Government’s pledge to backstop Fannie and Freddie, by injecting up to $200 billion into them and offering to loan billions of dollars on favourable terms, means that those guarantees - which had been in doubt as the groups’ suffered from $14 billion in losses between them in the past year - would now be honoured.

The 12 federal home loan banks, set up to provide cheap mortgage financing, will also be eligible to borrow cheaply from the US Treasury.

A failure by the Government to back Fannie and Freddie would have sent the valuations tumbling on many bonds they guaranteed on concerns that they would not pay out in the event of a default. This could have saddled the debt holders with hundreds of billions of dollars of losses.

Chris Whalen, of Institutional Risk Analytics, said: “The bondholders can go back to sleep again. But this deal is not so good for the equity holders.”

Shareholders in Fannie and Freddie have already lost tens of billions of dollars in the group in the past year as their stock prices have tumbled by more than 80 per cent.

The groups’ common shareholders, who owned just over $10 billion of equities on Friday night, are expected to see their holdings virtually wiped out today as a result of yesterday’s Government announcements.

“If you hold the stock, you’re going to have to write it off. I imagine the shares will dive on Monday,” Mr Whalen said.

Sovereign Bancorp, a regional lender based near Philadelphia, will be among the biggest casualties. The $588 million securities it holds in Fannie and Freddie represent about 13 per cent of its capital, according to a report by Keefe, Bruyette & Woods.

Fannie and Freddie also have about $15 billion of corporate bonds outstanding. These are different from the mortgage-backed bonds - which finance their interest payments with the interest on the underlying home loans - because they are paid out of Freddie and Fannie’s profits.

Mr Whalen estimates that these bonds could decline in value by about 10 per cent, leaving their holders with a collective loss of about $1.5 billion.

“The mortgage-backed bonds are guaranteed. The Government will make sure they get paid. But the corporate bonds do not have the same obligations and it may be that the Government decides to share some of the losses.”