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BofA Joins Foreign Investors Fueling Record Ginnie-Fannie Gap

BofA Joins Foreign Investors
The Bank of America Corp. logo is displayed in front of a branch in Galveston, Texas. Photographer: Scott Eells/Bloomberg

Home-loan securities guaranteed by Ginnie Mae are trading at about record premiums over Fannie Mae bonds as foreign investors target debt with the strongest backing from the U.S. and lenders including Bank of America Corp. seek notes considered the least risky by regulators.

The price difference between U.S.-owned Ginnie Mae’s 4.5 percent, 30-year securities and similar debt from government-supported Fannie Mae has almost tripled this year to 3 cents on the dollar, exceeding 3.1 cents last month, according to data compiled by Bloomberg.

The widening signals the value of the explicit guarantee bestowed on Ginnie Mae debt by the U.S., even after Standard & Poor’s stripped the nation of its top credit grade in August and Fitch Ratings said this week it may review its AAA ranking. The government has vowed to protect holders of bonds insured by Fannie Mae and rival Freddie Mac after seizing the companies three years ago without officially guaranteeing their debt.

“If you’re an international buyer, you lean toward Ginnies because you’d rather have the full-faith-and-credit backing at any reasonable difference in spreads,” said Peter Hirsch, the New York-based head of U.S. dollar rates and agency mortgage trading at Royal Bank of Canada’s RBC Capital Markets unit.

Overseas investors own about $620 billion of the $5.3 trillion in U.S.-supported mortgage bonds. They will reinvest next year only into Ginnie Mae notes, adding about $100 billion, JPMorgan Chase & Co. analysts forecasted in a Nov. 23 report. Their Fannie Mae and Freddie Mac investments, which now are about half of the holdings, will shrink by about $75 billion, the analysts said.

Capital Standards

Banks across the world are also favoring Ginnie Mae “more and more” as they prepare for tougher capital standards under the Basel III international accord, as well as proposed rules demanding they hold specific amounts of liquid assets, RBC’s Hirsch said.

Bank of America, the second-largest U.S. bank by assets, sold $24 billion of Fannie Mae and Freddie Mac notes last quarter and bought $26 billion of Ginnie Mae bonds, “likely to optimize its risk-weighted assets,” Barclays Capital analysts said in a Nov. 28 report based on data released last month. The lender held $234 billion of U.S. government-tied mortgage bonds as of Sept. 30, the most among domestic banks.

Jerry Dubrowski, a spokesman for Charlotte, North Carolina-based Bank of America, declined to comment.

While lenders don’t have to hold any capital against Ginnie Mae bonds under risk-based rules, regulators assign weightings of 20 percent to Fannie Mae and Freddie Mac debt. That’s even with the U.S. promising unlimited aid to the mortgage-finance firms through 2012 and then $274 billion in extra capital.

Mortgage-Debt Returns

Ginnie Mae, which is based in Washington and formally named the Government National Mortgage Association, was created in 1968 as a U.S. government-owned corporation and issued the first mortgage-backed security two years later. Loans insured by the Federal Housing Administration, which allow down payments of as low as 3.5 percent for home purchases, account for most of the mortgages in its $1.2 trillion of bonds.

Ginnie Mae securities have returned 7.2 percent this year, with all government-supported U.S. mortgage bonds gaining 5.4 percent, compared with 3.2 percent for global corporate bonds, Bank of America Merrill Lynch index data show.

Fitch lowered its outlook of the nation’s credit grade to negative on Nov. 28 after a congressional committee failed to agree on deficit cuts.

Fannie Mae, which is headquartered in Washington, and McLean, Virginia-based Freddie Mac have drawn about $185 billion in capital from taxpayers since September 2008. Their regulator projected in October that cumulative U.S. injections will range from $220 billion to $311 billion at the end of 2014.

‘Whatever is Needed’

Few U.S. investors doubt the nation will “do whatever is needed” to ensure repayment of their debt, said Timothy Cunneen, a senior portfolio manager at Smith Breeden Associates Inc. “Without Fannie and Freddie, clearly borrowing costs would be significantly higher and that’s just not an outcome that’s palatable to anyone.”

While many overseas investors share that view, they risk scrutiny amid “the unresolved questions around the future of Fannie and Freddie” when buying their bonds, said Cunneen, whose firm oversees $6.1 billion from Durham, North Carolina.

The JPMorgan analysts led by Matt Jozoff, who wrote in May that Ginnie Mae-Fannie Mae price gaps had reached “nosebleed” levels at amounts about 50 percent less than the current difference, said last month that “growing capital considerations for banks have also played a backseat role” in the continued expansion.

Regulatory Requirements

Changes to capital requirements under Basel III begin in 2013. A bank needs to hold $475 million of capital against $25 billion of Fannie Mae bonds to achieve a risk-based ratio of 9.5 percent, the highest base required under plans for so-called systemically important financial institutions. For Ginnie Mae securities, the amount is zero.

“Ginnies do not appear to offer a lot of fundamental value at present prices but if you were a bank, what would you be doing?” said Todd Abraham, co-head of the government and mortgage-backed fixed income group at Pittsburgh-based Federated Investors Inc., which manages about $350 billion of assets.

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