Fannie Mortgage-Bond Spreads Narrow as U.S. Eases Bailout Terms

Relative yields on Fannie Mae (FNMA) and Freddie Mac mortgage securities that guide home-loan rates declined as the U.S. Treasury Department said it would alter their bailout agreements, while spreads on the companies’ own debt narrowed and their preferred shares tumbled.

A Bloomberg index of yields on Fannie Mae-guaranteed mortgage bonds trading closest to face value fell about 1 basis point to 129 basis points, or 1.29 percentage points, higher than an average of five- and 10-year Treasury rates as of 3 p.m. in New York. The spread yesterday reached the widest in a month. The yield relative to U.S. government debt on its unsecured notes due August 2017 fell 4 basis points to 14 basis points, the lowest since the debt’s July 18 issuance.

Adjustments to the companies’ government support will end a requirement that they pay 10 percent dividends annually on the capital they’ve drawn from the Treasury. Recent earnings at Fannie Mae and Freddie Mac have often been too low to cover that amount, and the government this year will stop allowing them to tap unlimited taxpayer funds to fill any shortfalls.

The companies’ regular need to borrow money from the Treasury to pay the dividends, increasing their burden and leaving them exposed to eventually running out of aid, seemed like a “never-ending, un-virtuous cycle” that worried potential buyers of their bonds, Robert Rowe, an agency debt analyst at Citigroup Inc., said in a telephone interview. “You could potentially see some investors, particularly some foreign investors, that have moved out of the market come back to it.”

Reducing Holdings

Fannie Mae’s 8.25 percent preferred perpetual shares slumped 55 percent to $1.05 as of 4 p.m. after the Treasury said the companies would begin providing future earnings to the government. The U.S. ordered Fannie Mae and Freddie Mac to cease paying preferred-stock dividends after their seizures in 2008. Buyers speculated that the companies would eventually recover, repay the U.S. and resume the payouts, or that the shares would be valuable when the firms get restructured.

The Treasury also is directing the firms to wind down their holdings of mortgage securities and loans faster. The new bailout agreements will require the companies to reduce their holdings at a pace of 15 percent a year, up from 10 percent. The cap will start at $650 billion as of December.

Supply Increase

The accelerated reduction may increase the supply of government-backed mortgage bonds from Fannie Mae’s portfolio available to others by about $33 billion in 2013, according to a report today by Credit Suisse Group AG analysts including Mahesh Swaminathan. The extra amount from both Fannie Mae and Freddie Mac (FMCC) will probably total between $50 billion and $60 billion “in 2014 and beyond,” they wrote.

The companies’ portfolios, which they fund by selling the unsecured notes, are a separate business from their bond guarantees, which financed about two-thirds of new U.S. mortgages last quarter, according to data from newsletter Inside Mortgage Finance.

Declines in Freddie Mac’s portfolio have already been exceeding the required pace with its reported holdings falling in June to $581.2 billion, which Anish Lohokare, a BNP Paribas SA analyst, described in a note to clients as “well below” the required level. Fannie Mae’s investments were at $672.8 billion, he said.

“On first look, we do not see the formality of accelerating the rate of portfolio decline for Fannie and Freddie holdings to have any lasting footprint in the debt market,” Jim Vogel, a debt analyst at FTN Financial, wrote in a note. “Just the fact they were slowly shrinking was enough to help keep spreads” on their own debt “in line.”

Paying Dividends

Fannie Mae and Freddie Mac have taken a total of almost $190 billion in U.S. aid since they were put into conservatorship in September 2008 as mounting losses from the nation’s housing slump threatened to exacerbate a global financial crisis. The companies have paid back about $46 billion in the form of dividends.

The Treasury’s new agreement with the companies will require them to only turn over any earnings, meaning they won’t need to borrow more to cover the dividends in quarters when their profits are too small or non-existent. The compounding effect of the previous accord meant they could have run out of money within as little as seven years, Bank of America Corp. analyst Ralph Axel said in January.

After an earlier reworking of their agreements that offered unlimited funds to the companies as needed through the end of this year, Fannie Mae can tap about $125 billion more in the future, with Freddie Mac having about $150 billion remaining if needed.

Fannie Mae this month reported that rising home prices helped push its net income to $5.1 billion in the second quarter, enough to offset a $2.9 billion dividend payment to the Treasury. Freddie Mac reported net income of $3 billion in the second quarter and made a dividend payment to the Treasury of $1.8 billion. The company said it would not require U.S. aid for the first time since the first quarter of 2011.

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

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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