Small banks hurt by Fannie, Freddie may get help

By putting the full weight of its finances behind Fannie Mae and Freddie Mac, the government may have crushed the fortunes of about two dozen small banks.

The preferred shares of Fannie and Freddie, which banks of all sizes long considered to be safe investments that paid substantial dividends, are now virtually worthless under the terms of Sunday's federal takeover of the mortgage finance companies.

On Tuesday, banking regulators and representatives of minority-owned banks met at the Treasury Department to discuss the possible impact on small minority-owned banks and thifts with dangerously large holdings of Fannie and Freddie preferred stock. Because banks hold the preferred shares as part of their core capital, they likely will have to write off those losses.

"Of the very few banks with significant exposure, if the bank is otherwise healthy, we'll give them a reasonable time to work on their capital plan process," Kevin Mukri, a spokesman for the Office of the Comptroller of the Currency, the Treasury agency that oversees national banks, said Tuesday.

Astoria Financial Corp., Flushing Financial Corp. and Webster Financial Corp. _ all of which are publicly traded _ are among the small banks vulnerable to Fannie- and Freddie-related losses, according to Sandler O'Neill analyst Mark Fitzgibbon.

Astoria reported Tuesday that it expects to book a third-quarter charge for its investments in Freddie preferred stock, valued at $83.7 million, but said the charge would have a "minimal" effect on its capital position.

Other regional banks with heavy exposure to Fannie and Freddie preferred stock as a proportion of their capital include Westamerica Bancorp and Gateway Financial Holdings Inc., according to analysts at Keefe, Bruyette & Woods.

Because most of the smaller banks are not publicly traded, it is difficult to discern what their holdings of Fannie and Freddie securities are. Financial reports for all banks that are maintained by the FDIC and publicly available do not include that information.

It doesn't appear likely that the banks in question will fail, but some of them "may have to do some real scrambling," said Bert Ely, a banking industry consultant based in Alexandria, Va. That means cutting dividends, selling assets and other measures to quickly raise capital.

Analysts on Monday singled out Sovereign Bancorp Inc., a Philadelphia-based regional bank, and Cascade Financial Corp., the parent of Washington state-based Cascade Bank, as among the biggest potential losers from their holdings of Fannie and Freddie stock.

Among the two dozen banks most at risk are some minority-owned banks and thrifts _ a few of which could suffer a severe erosion of their capital as a result.

A wide range of U.S. large banking and insurance companies hold tens of billions of dollars in Fannie and Freddie preferred shares.

Prices of a company's preferred shares, in normal times, usually are more stable than its common stock.

The preferred shares usually pay a fixed dividend and have priority over common stock when it comes to dividends and bankruptcy liquidation. While slightly riskier than bonds, which have the highest priority in times of trouble, companies often invest in preferred shares for certain tax advantages.

On Monday, many classes of the two companies' preferred stock plunged around 80 percent in value. They continued to fall Tuesday, losing about 12 percent to 16 percent on average.

Under the rescue plan, the Treasury is ready to put up as much as $100 billion over time in each of the two mortgage companies to keep them afloat _ in exchange for preferred stock.

The regulators' forebearance toward hard-hit banks that submit plans for rebuilding their capital will be on a one-on-one basis.

The banking regulators and representatives from institutions met at Treasury on Tuesday to discuss the situation of minority-owned banks with holdings of Fannie and Freddie shares, at the request of Rep. Maxine Waters, D-Calif.

"The ramifications for some minority banks could be severe," said Michael Grant, president of the National Bankers Association, a group representing minority- and women-owned banks.

Under pressure now are minority-owned banks that bought Fannie's and Freddie's preferred stock because their status as government-sponsored companies "was considered and implied to be low-risk, secure and vanilla," Grant said in an e-mailed statement.

"These minority financial institutions _ who are serving distressed communities _ will be disproportionately affected" unless the government moves quickly to identify the banks with exposure to the preferred shares and give them regulatory relief, Grant said.

The comptroller's office estimates that less than 0.5 percent of the 1,640 banks it regulates have large concentrations of Fannie or Freddie shares.

"Across the industry, banks do not have significant exposure to" Fannie and Freddie stock, FDIC Chairwoman Sheila Bair said in a statement issued Sunday. "Any negative impact will be narrowly focused only on a few smaller institutions. Regulators will be working closely with those few banks to develop capital plans to assist their recovery."

For example, Sovereign held about $639 million of the mortgage giants' preferred securities at the end of the second quarter.

Cascade faces a "high likelihood" of needing to raise additional capital because of its Fannie and Freddie vulnerability, according to analyst Tim O'Brien of Sandler O'Neill. He noted that total risk-based capital at Cascade was $139 million as of June 30 and must stay above $130 million for Cascade to remain well-capitalized to meet regulatory requirements.