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Bondholders Fare Best In Takeover of GSEs

For nine months, commercial mortgage brokers, bankers, and their multifamily investor clients had been feeling what the rest of the world undoubtedly felt when the U.S. Treasury abruptly seized control of Fannie Mae and Freddie Mac — that the GSEs are the salvation of multifamily lending and could not be left to sink.

Acting in conjunction with the newly formed Federal Housing Finance Agency, the Treasury dismissed executives and board members and took control of the day-to-day operations of the GSEs. The new entity is now the surviving regulatory agency after combining the Office of Federal Housing Oversight and Federal Housing Finance Board.

Currently, a multifamily purchase or refinance transaction that can't make the grade as a GSE loan is rarely closed or otherwise written through an expensive alternative funding source.

Impact on operations

The question raised by multifamily lending and loan acquisition stakeholders is, what happens to the operations of organizations like the Fannie Mae Designated Underwriter and Servicer and agency bond trading desks? The simple answer for now is nothing. The Treasury has indicated that it is prepared to “invest” as much as $100 billion in each of the GSEs to keep them fulfilling their roles, creating a short-term fix.

Even though the long-term fix is unclear, the initial response from the lending community has been to lower rates, and many expect even more multifamily transactions will be funneled through the GSEs now than before. But until an alternative to Fannie and Freddie emerges for multifamily lenders, not much will change for the beleaguered loan origination industry.

Now that quarterly reporting to Wall Street is not a distraction for the GSEs, internal financial and corporate decisions affecting lending and investment programs may be completed more expeditiously. Nevertheless, all eyes continue to be on the agency bond trading and issuance business, especially with competition in the form of CMBS and other debt securities now noticeably absent.

One can be certain that investors will flock to agency bond sales not only because it is the only game in town for many, but also because it represents flight-to-safety buying. This will likely continue until the alternative — CMBS and other mortgage-backed instruments — emerge as welcome competition to the GSEs.

Real estate or corporate?

The GSEs' corporate bonds have always enjoyed a special privilege in the investment marketplace. And while specific pools of mortgages do not directly back these bonds, they are considered “real estate-related” investments and qualify for purchase by investors such as REITs and other institutional funds.

Though not agency bonds, they are tied to what was previously the implicit and now explicit backing of the Treasury. But corporate bondholders are about the only GSE investors that received good news when the mortgage liquidity giants went into conservatorship.

Common stockholders were virtually wiped out. Meanwhile, dividend payments to preferred stockholders were suspended until the entities emerge from under conservatorship, a big bite to swallow for many corporate investors.

Protection of bondholders took precedence over stockholders because many politically sensitive institutional investors such as pension funds, insurance companies, foreign central banks, and sovereign wealth funds hold these bonds. These investors could not be left holding severely impaired debt investments.

In the final analysis, these corporate bondholders are not only receiving preferential treatment based on their higher position in the order of payment in the event of default, but they also are holding the equivalent of a high-grade CMBS bond. And the high grade is based on the full strength of the U.S. Treasury.

However, as the real estate finance and investment markets continue to rely on the GSEs to shoulder just about all of the estimated $680 billion annual multifamily and residential origination marketplace, the Treasury Department's bold move is all the more ominous.


Federal National Mortgage Association
Fannie Mae (NYSE: FNM)
Federal Home Loan Mortgage Corp.
Freddie Mac (NYSE: FRE)
Employees 5,700 5,000
Market capitalization (9/23/08) $1.4 billion $854 million
52-Week stock high (10/04/07) $68.60 $66.88
52-Week stock low (9/17/08) $0.35 $0.25
Corporate Debt Outstanding $799 million $835 million
Sources: Fannie Mae, Freddie Mac, Dow Jones & Co.

W. Joseph Caton is managing director of Oxford, Conn.-based Hartford One Group, a real estate finance consultant.

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