Sovereign Could Feel Fannie, Freddie Pain

Sovereign Bancorp(SOV Quote - Cramer on SOV - Stock Picks) could be facing significant losses on its preferred stock investments in Fannie Mae(FNM Quote - Cramer on FNM - Stock Picks) and Freddie Mac(FRE Quote - Cramer on FRE - Stock Picks).

With concerns brewing that the U.S. government will privatize Fannie and Freddie because of their lack of adequate funding, debt holders of the two mortgage giants who are senior in the capital structure will likely see their investments protected.

However, the fate of common and preferred stockholders is much less certain, and in a worst-case scenario both could be wiped out, seeing their investments fall to zero.

Owners of Fannie and Freddie's common stock have already felt much pain, as both companies' share prices have fallen over 90% from their 52-week highs and are drifting closer to zero each day. Freddie shares were falling more than 16% to $2.65, and Fannie stock was down more than 7% to $4.51 Friday, after billionaire investor Warren Buffett said in a CNBC interview that he expected a government bailout.

Next up for bludgeoning could be the mortgage giants' preferred-stock holders, many of which are regional banks.

"Based on available information, we sense that large and regional banks have manageable exposures to preferred stock, with the exception of Sovereign," analysts at CreditSights said in a research note late Thursday evening.

Banks such as M&T Bank(MTB Quote - Cramer on MTB - Stock Picks), Fifth Third(FITB Quote - Cramer on FITB - Stock Picks) and U.S. Bancorp(USB Quote - Cramer on USB - Stock Picks) are among those with more manageable exposure than Sovereign, CreditSights said. BB&T(BBT Quote - Cramer on BBT - Stock Picks) owns none of these securities.

Sovereign owns 8 perpetual preferred stocks of Fannie and Freddie totaling $622.6 million, which already had a mark-to-market loss of $34.4 million, according to Sovereign's latest 10-Q filing in late July. This preferred stock represents about 5% of Sovereign's total securities and less than 1% of assets.

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