Aug. 27 (Bloomberg) -- Fannie Mae and Freddie Mac sold $3 billion of short-term notes at yields that suggest the largest U.S. mortgage-finance companies are still capable of financing their businesses without government assistance.

The yields on the debt relative to benchmark rates, while higher than in sales earlier this month, remain lower than a year ago, data compiled by Bloomberg show.

Investors have been watching the debt sales for any ``tell- tale'' signs that Washington-based Fannie and Freddie of McLean, Virginia, can't fund themselves, UBS AG analysts in New York including William O'Donnell wrote in a report. Today's spreads were wide enough to attract demand, yet narrow enough to dim speculation the government-sponsored companies will be forced to turn soon to Treasury Secretary Henry Paulson for support.

``The rising spreads clearly show some buyers are backing away from the market, but in general I think money funds continue to buy and hold Fannie and Freddie debt,'' said Peter Crane, president of Crane Data LLC, a firm in Westborough, Massachusetts, that tracks money-market funds. ``They assume the short-term money-market debt will be safe and covered.''

Rescue Plan

In Fannie's sale, the company paid the most relative to bank borrowing in a weekly auction since July 23, when lawmakers passed Paulson's emergency rescue plan. Freddie paid the most relative to the London interbank offered rate in a monthly auction since July 2007. Higher debt costs may lessen the companies' ability to use revenue from their $1.6 trillion portfolios to offset rising foreclosure-related expenses.

Fannie sold $1 billion of three-month notes at a yield of 2.58 percent, the company said. That's about 89 basis points more than U.S. Treasuries and 23 basis points less than three-month Libor, compared with 76 basis points and 31 basis points in a sale last week.

Freddie raised $1 billion of one-month debt at a yield of 2.28 percent, or 66 basis points more than Treasuries and 18 basis points less than one-month Libor. A month ago, the company sold similar debt at yields 55 basis points above Treasuries and 22 basis points below Libor.

Merrill Lynch & Co. analysts Kenneth Bruce and Cyrus Lowe today said a bailout of Fannie and Freddie is ``premature'' because losses won't cause capital to deplete for several quarters. Paulson, who was granted the power last month to offer capital and loans to Fannie and Freddie, hasn't detailed plans for any support, leaving some bond buyers wary.

Expand Homeownership

Fannie rose for a fifth straight day, climbing 86 cents, or 15 percent, to $6.48 in New York Stock Exchange composite trading. Freddie increased for a third day, advancing 78 cents, or 19 percent, to $4.75. The companies have each lost more than 83 percent of their market values this year.

U.S. House Financial Services Committee Chairman Barney Frank said yesterday in an interview with Bloomberg Television that he doesn't know if a government bailout is ``inevitable,'' adding that the two companies are performing better than many banks, mortgage lenders and securities firms.

Congress created Fannie and Freddie to expand homeownership and provide market stability. They make money by buying mortgage and related bonds, funding their purchases with lower-cost debt, and by guaranteeing home-loan securities. The companies have about $200 billion of debt maturing through Sept. 30.

Overseas

The Treasury is paying more attention to the yields paid by Fannie and Freddie in sales of long-term debt than their short- term borrowing, said Paul Colonna, the chief investment officer for fixed income at GE Asset Management in Stamford, Connecticut.

``That's where all the large institutional players overseas are playing,'' he said today. ``We're comfortable with the credit risk profile of both the short term and long term senior debt.''

Fannie also sold $1 billion of six-month debt today at a yield of 2.87 percent, about 93 basis points above Treasury bills and 28 basis points below six-month Libor, compared with 88 basis points and 31 basis points last week. A basis point is 0.01 percentage point. Three-month Libor is currently set at 2.81 percent, while six-month Libor is at 3.12 percent.

Yield spreads on short-term agency debt, the term for notes sold by Fannie, Freddie and the government-chartered Federal Home Loan Banks, have been mostly below historical averages this year, according to data complied by Bloomberg.

In the five years ended June 30, 2007, yields on 90-day agency debt averaged with 18 basis points below three-month Libor, a measure of the average rate banks at which banks can borrow. So far this year, they've averaged 50 basis points. Since mid-2007, the spread reached as high as 95 basis points on Sept. 13, and as low as 15 basis points on July 23.

No Place to Go

``There's no other place to go, now that money funds are out of SIVs,'' Crane said. ``A lot of people are looking at the rise in spreads as a godsend.''

Sales of commercial paper by SIVs, or structured investment vehicles, once an almost $400 billion market, halted in mid-2007 after buyers became concerned that some of the funds invested in bonds tied to subprime mortgages.

Fannie and Freddie's rising relative borrowing costs have come with spreads on the mortgage-backed securities they invest in also climbing. The option-adjusted spread on fixed-rate home- loan bonds guaranteed by the companies or U.S. agency Ginnie Mae rose to 151 basis points yesterday, from 108 basis points on June 2, according to Lehman Brothers Holdings Inc. data.

If their borrowing costs climb to ``some kind of distressed level, outside of corporate AAAs,'' Fannie and Freddie might be forced into sales of mortgage bonds, hurting prices and forcing up loan rates, FTN Financial Capital Markets mortgage-bond strategist Walt Schmidt said in an interview yesterday.

The debt of top-rated U.S. corporate borrowers yields about 175 basis points more than U.S. Treasuries, compared with the about 82 basis point spread on the long-term debt of Fannie and Freddie, according to Merrill index data.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net.

Last Updated: August 27, 2008 17:00 EDT