Fannie Mae Preferreds: Count Towards Bank Capital?

Via Dealbreaker comes a WSJ Deal Journal post that makes the following rather odd claim:

But the fact remains that the government allowed banks to count Fannie and Freddie preferred shares toward their capital ratios, which made them appear safe.

I don’t understand this. I do see from the enormous Federal Reserve Bank Supervision Manual that:

U.S. government–sponsored agencies are agencies originally established or chartered by the federal government to serve public purposes specified by the U.S. Congress. Such agencies generally carry out functions performed directly by the central government in other countries. The obligations of government-sponsored agencies generally are not explicitly guaranteed by the full faith and credit of the U.S. government. Claims (including securities, loans, and leases) on, or guaranteed by, such agencies are assigned to the 20 percent risk category. U.S. government–sponsored agencies include, but are not limited to, the College Construction Loan Insurance Association, Farm Credit Administration, Federal Agricultural Mortgage Corporation, Federal Home Loan Bank System, Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac), Federal National Mortgage Association (FNMA or Fannie Mae), Financing Corporation (FICO), Postal Service, Resolution Funding Corporation (REFCORP), Student Loan Marketing Association (SLMA or Sallie Mae), Smithsonian Institution, and Tennessee Valley Authority (TVA).

I assume “securities” includes preferred shares, but I can’t find that in so many words. If so, then FNM prefs would be assigned a 20% risk weight rather than the normal 100% … in much the same way as AAA sub-prime paper was assigned a 20% risk-weight! See The role of ratings in structured finance: issues and implications :

Standardised risk weights for securitisation exposures: AAA to AA–, 20%; A+ to A–, 50%; BBB+ to BBB–, 100%; BB+ to BB– receive 350% for investors, but deduction for originators; B+ and below and unrated positions will have to be deducted in all cases, with the exceptions mentioned above. See Himino (2004) for a short overview of the Basel II framework.

This little example of what I suspect is a simple error would not normally be worth a post all to itself – but I think I’ve seen this claim elsewhere and find it puzzling. What on earth does the WSJ mean by saying that Fannie Mae prefs can count towards a bank’s capital? Any elucidation would be appreciated.

Update: Dealbreaker says:

Regulators require to banks to maintain a capital cushion against losses on loans. This capital requirement can be met by holding cash or cash equivalents and certain investments that were considered relatively risk-free.

… which makes no sense to me at all. I’ve asked for clarification in the comments.

Felix Salmon asks why the prefs were being held at all; the first commenter responds:

I believe that the capital requirements for GSE equity differ among the regulators. I think the risk weight is as low as 20% for GSE equity per at least one of the agencies.

… which makes perfect sense, but is not what is being said by Dealbreaker and the WSJ.

Update: OK, there’s a commentator on Dealbreaker who states:

The biggest owners of GSE pfds relative to the size of their balance sheet are smaller banks — state-chartered and thrifts. State-chartered banks and thrifts have a 100% risk weighting on GSE preferreds, while national banks have only a 20% risk weighting.

… but he doesn’t give chapter and verse.

In the “oldie but goodie” category comes a paper from the Cato Institute – The Mounting Case for Privatizing Fannie Mae and Freddie Mac … dated December 29, 1997! Anyway, any specifics in this paper with respect to bank supervision will have been long superseded, but it is claimed that:

12 C.F.R. 3-Appendix A(3)(a)(2)(vi) (Office of the Comptroller national bank regulations). Such securities are given a 20 percent risk weight, which is not as favorable as the 0 percent risk weight of U.S. government securities, but is more favorable than the 50 percent risk weight generally placed on privately issued mortgage-backed securities. The Office of Thrift Supervision’s regulation, 12 C.F.R. 567.6(a)(1)(ii)(H), has slightly different standards than the banking agencies, allowing certain “high quality mortgage-related securities” other than GSE securities to be accorded a 20 percent risk weight. 12 U.S.C. 24(7) details diversification standards for national banks.

And finally … the Holy Grail … Assessing the Banking Industry’s Exposure to an Implicit Government Guarantee of GSEs … and FDIC paper from 2004. Now I have to find something more recent that links to it!

There were no links I could find … but there is a fascinating letter from the Federal Home Loan Bank of New York.

Leave a Reply

You must be logged in to post a comment.