Fannie-Freddie Fallout Will Hit Gateway Financial and Midwest Banc

 |  Includes: GBTS, MBHI, SOV
by: Edward Harrison

If you are looking for the fallout from the Fannie and Freddie Nightmare on Wall Street, look no further than Gateway Financial (GBTS) and Midwest Banc (MBHI). These two regional banks have nearly one-third of their capital tied up in GSE preferred stock, which is now worthless.

On August 29th, BusinessWeek reported that these two regional banks had the largest exposure as a percentage of capital to GSE preferred stock. As preferred shares are now nearly worthless as a result of Fannie and Freddie's conservatorship, these banks may also be effectively bankrupt.

BusinessWeek said the following on August 29th.

Ultimately, the losses to shareholders will be determined by how Treasury decides to treat the companies' equity if it intervenes to recapitalize the agencies. The market for preferreds is pricing in the risk of some form of government intervention, with some issues trading for as little as 50 cents on the dollar, compared with around 92 cents on the dollar at the end of June, says Sam Caldwell, an analyst who covers regional banks for Keefe, Bruyette & Woods [KBW].

It's mainly individual investors who have borne the brunt of the losses on the agencies' common stock, but regional banks, insurance companies, and other financial institutions have taken the hit on the devalued preferreds, and those with a substantial portion of their capital tied up in these securities can ill afford to have all their value wiped out under a government bailout. Fannie and Freddie preferreds account for at least 32% of the tangible capital held by two regional banks—Gateway Financial Holdings and Midwest Banc Holdings—and 5% or more for a slew of others, according to an Aug. 25 report by Caldwell.

While he believes large-cap banks have limited exposure to agency preferreds, Caldwell found 38 banks with aggregate exposure of $1.3 billion, and 81 other banks that said they didn't hold any preferreds.

A day of reckoning for losses on the agencies' preferreds could be Sept. 30, when firms will need to mark down the value of the assets on their balance sheets to fair market value. A few regional banks have already taken writedowns for other-than-temporary impairment on the preferreds they hold. Earlier this week, JPMorgan Chase (NYSE:JPM) said the value of its preferreds has been halved to $600 million this quarter and hinted it will take a charge on those assets when it reports third-quarter earnings.

There are others as well. In the NY Times:

Sovereign Bancorp (SOV), a regional lender near Philadelphia, holds about $588 million of the securities, about 13 percent of its tangible capital, according to a research report by Keefe, Bruyette & Woods, a securities broker.

There is a lot more exposure here to get a hold of. The Bloomberg article below does a good job of summing up the most vulnerable financial service companies. But, needless to say, Gateway and Midwest Banc are not looking good.

Fannie Mae and Freddie Mac: A Damage Report - BusinessWeek
Fannie and Freddie threat to banks - FT
Fannie, Freddie Preferreds Batter Sovereign, Midwest - Bloomberg
Few Stand to Gain on This Bailout, and Many Lose - NY Times

Disclosure: No position in stocks mentioned.