Sovereign Bancorp ( SOV) could be facing significant losses on its preferred stock investments in Fannie Mae ( FNM) and Freddie Mac ( FRE). 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), Fifth Third ( FITB) and U.S. Bancorp ( USB) are among those with more manageable exposure than Sovereign, CreditSights said. BB&T ( BBT) 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.
While Sovereign said the unrealized losses were temporary in nature, the company also warned that the issue could get worse. "To the extent the market conditions do not improve and the values for these securities do not stabilize, it is possible that Sovereign could have an additional other than temporary impairment charge in future periods," the company said in the filing. CreditSights estimates that a total write-off of the preferred stock investments in Fannie and Freddie would result in a material impact to Sovereign's earnings. Sovereign booked a pretax profit of $157 million in the second quarter; thus a full write-off of the preferred stock could wipe out about four quarters of earnings, CreditSights said. Shares of Sovereign have already fallen 20% this week on the fresh worries about a government bailout of Fannie and Freddie. On Friday, shares traded down 4% to $7.94.