Moody's cuts Fannie's and Freddie's ratings

Fannie Mae (FNM) and Freddie Mac (FRE) plunged anew after Moody’s cut its ratings on the companies’ preferred stock, citing rising losses and the possibility of a government bailout of the government-sponsored mortgage finance companies. Fannie Mae, the better capitalized of the two, fell 7%, while smaller Freddie Mac plunged 17% in late morning New York trading.

Moody’s cut its outlook for the mortgage firms’ subordinated debt to negative from stable, whle cutting Fannie and Freddie’s bank financial strength ratings to D-plus from B-minus. That downgrade reflects the likelihood the firms will require “extraordinary financial assistance,” either from the government or shareholders. Last but not least, Moody’s affirmed Fannie and Freddie’s senior debt ratings.

“Given Fannie Mae’s and Freddie Mac’s importance to the U.S. mortgage market, we believe there is a very high level of support for their debt from the U.S. Treasury,” said Brian Harris, a Moody’s senior vice president. “And, given these [government-sponsored entities'] more limited ability to raise capital and grow their portfolio to accomplish their public policy role in a time of mortgage market turmoil, we believe that there’s an increased probability of actual support coming from the U.S. Treasury.”

Moody’s said the reduced preferred stock rating reflects a rising “risk of dividend omission on the preferred stock.” Investors fear any additional government support of the companies could wipe out common and preferred shareholders, though Treasury Secretary Henry Paulson has said he wants to maintain the firms’ current structure.

Moody’s also cited the firms’ “constricted” financial flexibility given the plunge in their shares, which makes it harder for them to raise new capital, and concerns about the performance of the companies’ mortgage portfolios, which could reduce capital to the point where the companies would no longer pay dividends on the preferred stock.