Mortgage Bonds Imperiled by $17 Billion of Sales: Credit Markets
Fannie Mae and Freddie Mac are set to auction as much as $17 billion of mortgage bonds they acquired before the real estate collapse to meet a regulatory directive, potentially straining demand at the same time the Federal Reserve considers a stimulus pullback.
The offerings by year-end of residential and commercial securities without government backing will follow sales of about $22 billion the past four months from the government-controlled companies, according to Deutsche Bank AG. The auctions are adding to the $7 billion of new commercial-mortgage bond deals that Wall Street is planning this month, the biggest pipeline since Fannie Mae and Freddie Mac began the sales in May.
Investors are bracing for a pullback by the Fed from its unprecedented support for the economy as soon as this week. While the previous sales haven’t roiled markets, the future offerings may weigh on prices if Fannie Mae and Freddie Mac start to jettison riskier types of the debt, according to Brean Capital LLC’s Scott Buchta.
“That could certainly have a bigger impact,” said Buchta, the New York-based brokerage’s head of fixed-income strategy. Dealers and investors readily absorbed the initial auctions because the “bonds have been higher quality in nature,” he said.
Fannie Mae and Freddie Mac, which were seized by the U.S. five years ago this month, have persisted with the sales even as concern the Fed will slow $85 billion of monthly bond purchases interrupted a rally in the debt. The auctions are part of actions meant to shrink the firms and reduce their risks, putting new burdens on private investors as the government also cuts federal spending.
Residential mortgage securities not backed by the government lost about 3.7 percent on average in June and July, before advancing 0.55 percent last month to bring gains this year to 5.7 percent, according to Citigroup Inc. While bonds tied to commercial properties have lost 1.3 percent since May and 1.1 percent this year, the debt has outperformed Treasuries by 0.4 percentage point in 2013, Bank of America Merrill Lynch index data show.
Fannie Mae and Freddie Mac have primarily sold bonds linked to apartment buildings, totaling about $14 billion of securities, because that debt fetches the highest prices among the holdings they were asked to reduce, according to Deutsche Bank analyst Harris Trifon. One bond issued in 2006 by Wachovia Corp. and sold in a July 18 auction would trade at almost 109 cents on the dollar, according to Bloomberg Valuation estimates.
Fidelity Investments and BlackRock Inc. (BLK) have been purchasing such debt, according to fund disclosures and auction lists compiled by data provider Empirasign Strategies LLC. James Aber, a Fidelity spokesman, declined to comment. Lauren Post, a BlackRock spokeswoman, didn’t return e-mail messages.
“We do expect some pushback” if “some of the key buyers of these bonds in recent months slow their purchases,” Stamford, Connecticut-based Jefferies Group LLC analysts led by Lisa Pendergast wrote in a Sept. 4 report.
Fannie Mae and Freddie Mac have sold almost $7.5 billion of non-agency securities backed by home loans, many of which are considered relatively safe because they were issued before the most reckless lending in 2006 and 2007, according to JPMorgan Chase & Co. The firms also own riskier bonds from those years backed by subprime and Alt-A loans, soured investments that contributed to the need for their taxpayer-funded bailouts.
The two companies hold $163 billion of privately issued mortgage bonds, guarantee another $4.3 trillion of mortgage debt and own almost $370 billion of those securities or Ginnie Mae-backed notes. They’ve been paring the investments after the Federal Housing Finance Agency gave executives a goal in March of selling at least 5 percent of illiquid holdings this year.
The FHFA “is pleased with the progress Fannie Mae (FNMA) and Freddie Mac have made,” Denise Dunckel, a spokeswoman for the agency, said in an e-mail. “As noted in the 2013 scorecard, FHFA will consider market conditions in evaluating performance under this target.”
Thomas Fitzgerald, a spokesman for McLean, Virginia-based Freddie Mac, declined to comment except to say that any sales need to be “economically sensible and well-controlled,” as stipulated by the FHFA.
The firms would probably slow sales if relative yields widened “sharply,” Barclays Plc analysts led by Keerthi Raghavan wrote in an Aug. 9 report. Top-ranked bonds linked to commercial mortgages are yielding 129 basis points more than Treasuries, down from a 2013 peak of 153 basis points on July 8, Bank of America Merrill Lynch index data show. Spreads were as narrow as 88 on Jan. 14.
“We are working with FHFA to meet the goals of the conservatorship scorecard for 2013,” Callie Dosberg, a spokeswoman for Washington-based Fannie Mae, said in an e-mail.
The two companies, which have returned to profitability after almost $190 billion of taxpayer-funded capital injections, are also being ordered to increase what they charge to insure new bonds, reduce their total portfolios and issue notes that share the risk of homeowner defaults. Freddie Mac (FMCC) sold $500 million of those new securities in June, and Fannie Mae began this month discussing a potential transaction with investors.
While the firms also hold a combined $536 billion of loans that aren’t packaged into securities, they aren’t likely to sell those to meet asset-reduction goals because bonds are easier to sell in bulk and have a larger pool of buyers, Jefferies’s Pendergast said. Fannie Mae had $336 billion of such loans as of July, mainly delinquent or modified debt, while Freddie Mac owned $200 billion, monthly disclosures show.
In their latest auction on Sept. 10, the $1.4 billion of home-loan bonds “traded in line with expectations,” Citigroup analysts Roger Ashworth and Raja Narayanan wrote in a Sept. 12 report. An offering last month was met with a “rather tepid response,” JPMorgan analyst John Sim said in a Sept. 6 report. He predicted investors returning from summer vacations in the U.S. would see value in the notes, many of which still carry investment grades.
Some of the non-agency sales may have required Wall Street banks to boost holdings to offset weak investor demand, Brean Capital’s Buchta said. Primary dealer inventories climbed to $15.7 billion as of Sept. 4, from $11.9 billion on June 5, Fed data show. Holdings of commercial-mortgage bonds fell to $12.5 billion from $14.5 billion.
Issuance in non-agency securities tied to new home loans totals about $12 billion this year, up from $3.5 billion in all of 2012, while commercial-bond sales exceed $52 billion, compared with about $40 billion, according to data compiled by Bloomberg.
Investors have been drawn to the commercial-mortgage bonds being sold by Fannie Mae and Freddie Mac because of their relatively short duration and “cashflow stability,” Pendergast said. The bonds have so-called credit enhancement that protects buyers from the first 70 percent of losses if borrowers default.
The timing of future sales will be “crucial” as credit markets gyrate amid the Fed’s decision on whether to taper, U.S. budget negotiations in Congress and the conflict with Syria, Deutsche Bank analysts said in a Sept. 4 report.
Volatility “will increase the concessions investors and dealers require to provide liquidity,” the New York-based analysts said.
Elsewhere in credit markets, the cost to protect against losses on U.S. corporate bonds fell to the lowest in almost six weeks. Spectra Energy Corp. (SE), the pipeline owner that has promised to sell U.S. assets to a partnership it controls, is selling benchmark bonds in three parts to help fund the transfer.
The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, dropped 2.9 basis points to a mid-price of 74.2 basis points as of 10:51 a.m. in New York, according to prices compiled by Bloomberg. The index fell to as low as 73.9, the lowest intraday level since Aug. 6.
In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings declined 3.5 to 94.5. The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a swap protecting $10 million of debt.
Bonds of New York-based Verizon are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 22.2 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The company’s $15 billion of 6.55 percent, 30-year securities, the biggest portion of its record $49 billion bond sale last week, rose 2.3 cents to 110.6 cents on the dollar to yield 5.8 percent at 10:48 a.m. in New York, Trace data show.
Spectra may sell five-, 10.5- and 30-year debt as soon as today, according to a person with knowledge of the transaction. Proceeds will be used by unit Spectra Energy Partners LP (SEP) to purchase the gas distributor’s remaining U.S. transmission and storage holdings.
The new bonds may be rated Baa3, the lowest level of investment grade, by Moody’s Investors Service, said the person, who asked not to be identified because terms aren’t set. Bank of America Corp., JPMorgan Chase & Co., Morgan Stanley and Royal Bank of Canada are managing the offering for the Houston-based company. Benchmark sales are typically at least $500 million.
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