Fannie Mae, Freddie Mac Should Unwind Portfolios Amid Demand, Pimco Says
Fannie Mae and Freddie Mac, the housing-finance companies supported by U.S. taxpayers, should take advantage of demand for government-backed mortgage debt and sell their holdings, according to Pacific Investment Management Co.
“Since the government’s going to want to unwind them at some point anyway, why not do it at the best levels ever?” Scott Simon, the mortgage-bond head at Newport Beach, California-based Pimco, manager of the world’s biggest fixed- income fund, said in a telephone interview. “It’s good for taxpayers, good for stakeholders, good for everybody.”
The average price of the $5.2 trillion of so-called agency mortgage bonds guaranteed by Fannie Mae and Freddie Mac or federal agency Ginnie Mae rose last week to an all-time high of 106.3 cents on the dollar, according to Bank of America Merrill Lynch’s Mortgage Master Index. The Federal Reserve said today it would replace its contracts to take delivery of certain bonds with other debt, reflecting a lack of supply in the market.
Investors have viewed the mortgage obligations as a haven amid Europe’s sovereign debt crisis and as signs of a slowing U.S. economy roil markets. Average values, which have also risen on speculation that homeowner refinancing won’t accelerate and that the Fed will hold short-term interest rates at record lows, have climbed from 104.2 cents on March 31, when the Fed stopped entering contracts to buy $1.25 trillion.
‘Appalled’ at Behavior
“If they just hold it all, they’ll make much, much less money,” and potentially report losses under accounting rules, Simon said in the interview last week, referring to Fannie Mae and Freddie Mac. “I’m appalled as a taxpayer they aren’t selling.”
Janis Smith, a spokeswoman for Washington-based Fannie Mae, Michael Cosgrove, a spokesman for McLean, Virginia-based Freddie Mac, and Corinne Russell, a spokeswoman for the Federal Housing Finance Agency, their regulator, declined to comment.
The companies, which have received $145 billion of U.S. capital injections, hold $1.5 trillion of housing loans and securities combined, including almost $700 billion of agency mortgage bonds, down from almost $840 billion at the start of the year, according to their latest disclosures. The U.S. has directed each of them to keep their portfolios below $900 billion.
The companies also guarantee $3.9 trillion of housing debt they don’t hold. This year, they’ve increased the amount of un- securitized mortgages in their investment portfolios, as they buy delinquent loans out of the securities they back to reduce expenses, while paring their securities holdings mainly by allowing them to pay down.
While the Obama administration has deferred developing a proposal for the so-called government-sponsored enterprises’ future with the U.S. housing market still struggling, Treasury Secretary Timothy Geithner told lawmakers in March that his department “remains firmly committed to ensuring that the GSEs’ retained portfolios are substantially reduced.”
Most proposals for leaving the firms as government-linked or making them U.S. agencies envision maintaining smaller portfolios or none at all, according to a Government Accountability Office report in September. Caps on their portfolios are scheduled to drop by 10 percent annually.
It “would be appropriate” for the companies to start selling securities, though they may be resisting the idea, said Anthony Sanders, a professor of finance at George Mason University in Fairfax, Virginia.
Return to Profitability
“They actually believe they will be put back to the market again,” said Sanders, also a former mortgage-bond research director at Deutsche Bank AG. “And the larger the portfolios they retain, in theory, the easier it is for them to return to being profitable businesses.”
Fannie Mae and Freddie Mac should sell “every” mortgage bond they own with 5 percent, 5.5 percent and 6 percent coupons, while allowing their own debt to mature, be retired through contractual call options or buybacks, or be offset with interest-rate swap contracts, Simon said.
The least expensive coupons are the so-called current- coupon bonds that most directly affect home-loan rates because they’re the ones into which lenders typically sell new loans, he said. Those “are the ones Fannie and Freddie don’t own.”
The New York Fed said in a statement today that it would use so-called coupon swaps to cancel its $9.2 billion of contracts to buy 5.5 percent Fannie Mae securities, and instead enter contracts to take delivery of other debt.
Retaining Low Rates
Sales by Fannie Mae and Freddie Mac of mortgage bonds, even those that don’t directly affect loan rates, may run counter to the government’s other actions meant to support markets, including promises by the Fed to keep its benchmark rate target unchanged for an “extend period.” At their April meeting, central bank policy makers debated when and how fast to sell holdings, signaling no rush to start.
Still, in unwinding their portfolios, Fannie Mae and Freddie Mac would also be removing their own corporate bonds from the market, lessening their supply at the same time, or entering swap contracts with similar effects, Pimco’s Simon said.
Pimco’s $228 billion Total Return Fund reduced its holdings of mortgage securities to 16 percent last month, down from 83 percent in January 2009, according to its website. Because the fund holds less of the debt than found in benchmark indexes, it would do better than rivals if the bonds underperform.
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