Regulators Will Oversee Subordinated Debt Deals

The next time Fannie Mae and Freddie Mac issue subordinated debt, it will be with the approval of their federal supervisor - the Office of Federal Housing Enterprise Oversight.

In 2000, the two government-sponsored enterprises made "voluntary" commitments to Congress to issue subordinated debt in an effort to increase market discipline and fend off GSE reform legislation.

They issued $18 billion in subordinated debt before running into accounting problems and suspended issuance.

Now they have entered in regulatory agreements with OFHEO that renew their commitments to issue subordinated debt. But this time around, the regulator will review their issuance plans before any offerings are made to investors.

"These agreements represent an evolution of voluntary actions to a set of enforceable commitments that will be overseen by OFHEO and will operate within a predictable supervisory framework," said OFHEO acting director Stephen Blumenthal.

Under the agreements, the two GSEs pledge to "take reasonable steps to maintain outstanding subordinated debt of sufficient size to promote liquidity and reliable market quotes."

The agreements also call for Fannie and Freddie to maintain a 4% capital ratio consisting of core capital (plus general allowance for losses) and subordinated debt.

Despite the agreements, the two GSEs are not expected to issue subordinated debt anytime soon.

"We are committed to resuming issuance of subordinated debt," Freddie spokesman Michael Cosgrove said. However, he noted Freddie would not resume issuance until the company becomes "current" in its financial reporting, which is expected to be in the first quarter of 2006. "We need to be current," he said. Freddie reported first- and second-quarter financial results on Aug. 31.

Freddie Mae issued $5.5 billion in subordinated debt in 2001 and 2002 before suspending issuance.

Fannie Mae officials declined to comment on when they will resume issuance of subordinated debt. The GSE issued $12.5 billion in subordinated debt before suspending its program after a $1.5 billion offering in November 2004.

Fannie noted that the agreements with OFHEO also cover commitments to maintain liquid assets so that GSEs can fund their operations without issuing unsecured debt for three months and to increase their interest rate risk and credit risk disclosures.

"We're pleased to have worked closely with our safety and soundness regulator, OFHEO, to agree to a process that will formalize the voluntary initiatives the company has undertaken to ensure market discipline, liquidity and capital," Fannie spokesman Chuck Greener said.

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