Almost four years after Fannie Mae was put into U.S. conservatorship, the Treasury Department has yet to erase skepticism that the nation’s biggest mortgage financier is as secure as government-owned Ginnie Mae.
While the difference between prices for Fannie Mae’s 3.5 percent home-loan bonds and similar Ginnie Mae debt with unconditional U.S. backing has narrowed about 0.3 cent to 2.2 cents on the dollar since the Treasury eased some bailout terms for Fannie Mae and Freddie Mac last week, it’s still above the average of the past two years, data compiled by Bloomberg show. The gap fell the most this year after the Aug. 17 announcement.
Fannie Mae’s lack of a full U.S. guarantee accounts for about half of the price difference, according to JPMorgan Chase & Co. analyst Brian Ye. Foreign investors typically stick with Ginnie Mae bonds for the extra safety while regulators push banks toward the debt by demanding they hold more capital for Fannie Mae notes. Morgan Stanley and Barclays Plc disagree on whether the bailout changes will boost demand from those buyers, even as other investors see little change in creditworthiness.
“They’re willing to give up some yield for the certainty of the government guarantee,” said Walt Schmidt, a mortgage strategist in Chicago at FTN Financial, the brokerage unit of First Horizon National Corp.
While Treasury Secretary Timothy F. Geithner had vowed Fannie Mae and Freddie Mac wouldn’t default, the previous terms of their taxpayer support created long-term dangers. The companies, which have taken almost $190 billion of U.S. capital since 2008, owed 10 percent annually on the amounts drawn.
Fannie Mae’s annual profits have never exceeded what it would have owed, while Freddie Mac’s did once, and both are being forced to shrink their own holdings of securities and loans that help to boost earnings, according to an Aug. 10 report by the Congressional Research Service. The Treasury’s new plan scraps the dividends and takes only the firms’ profits.
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. rose for a fourth day, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, climbing 0.2 basis point to a mid-price of 102 basis points as of 12:14 p.m. in New York, according to prices compiled by Bloomberg.
The measure typically rises as investor confidence deteriorates and falls as it improves. Credit-default 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 contract protecting $10 million of debt.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, was little changed at 18.5 basis points as of 12:15 p.m. in New York. The gauge narrows when investors favor assets such as company debentures and widens when they seek the perceived safety of government securities.
Bonds of Goldman Sachs Group Inc. are the most actively traded dollar-denominated corporate securities by dealers today, with 48 trades of $1 million or more as of 12:15 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
Fannie Mae was formed in 1938 as part of President Franklin D. Roosevelt’s New Deal. The Washington-based firm was split off from the government in 1968, though it retained certain perks and obligations that created an aura of taxpayer backing. McLean, Virginia-based Freddie Mac was started as a private company with similar government links in 1970 to foster competition.
Washington-based Ginnie Mae, once part of Fannie Mae, was created as a wholly U.S. government-owned corporation in 1968.
Fannie Mae and Freddie Mac are now each 80 percent owned by the U.S. after being seized in September 2008 as their mounting losses from the worst housing slump since the 1930s threatened to roil debt investors and deepen a global financial crisis.
Money managers such as Stable River Capital Management’s Chad Stephens see little reason to doubt the companies’ creditworthiness, thanks to their more explicit government support since the seizure and the systemic importance of financiers that guarantee about two-thirds of new home loans.
“We’d rather take the extra yield than get the full faith-and-credit guarantee” offered by Ginnie Mae debt, said Stephens, who manages the $2.4 billion RidgeWorth Institutional U.S. Government Securities Ultra Short Bond Fund. His fund, about 95 percent of which is invested in mortgage debt, has beaten about 82 percent of peers this year, Bloomberg data show.
Geithner’s adjustments to the mortgage companies’ bailout terms last week came less than five months before the government begins capping the funds Fannie Mae and Freddie Mac can tap to cover any losses or shortfalls in dividend payments. The amount will be limited to about $275 billion after Dec. 31.
The Treasury secretary, who told lawmakers last year that “Fannie Mae and Freddie Mac will not default on their obligations,” had on Christmas Eve in 2009 lifted a limit on their available aid through this year. Use of the remaining money for later dividends would have risked speeding how fast the amount was depleted by increasing the required payouts.
By turning their profits into government earnings, their new agreements leave the firms even more closely tied to the U.S., meaning the changes are “slightly positive” for the companies’ creditworthiness, according to an Aug. 17 report by JPMorgan. The bank’s mortgage-bond analysts were top-ranked last year in Institutional Investor polls, with Ye rated best for debt prepayments.
The changes also “may slightly increase” the odds that bank regulators will lower the so-called risk weights of 20 percent on their securities to match the zero percent weighting for Ginnie Mae debt, the analysts wrote.
“The real credit news will occur if the government took the step to actually guarantee the debt and MBS” of the companies, “which hasn‘t happened yet,” they said.
Under their capital rules, banks need to hold $475 million against $25 billion of Fannie Mae bonds to achieve a risk-based ratio of 9.5 percent. For Ginnie Mae securities, the amount is nothing. Proposed regulations demanding that banks hold specific amounts of easy-to-trade assets have also favored Ginnie Mae.
Spreads on Fannie Mae and Freddie Mac’s unsecured corporate debentures, which they use to finance their own portfolios of loans and securities, narrowed to the lowest relative to government notes since April 3 after the Treasury announcement.
Relative yields on their benchmark notes declined to 13 basis points on Aug. 20, before rising to 14 basis points through yesterday, according to a Bank of America Merrill Lynch index tracking $349 billion of bonds.
The shrinking market for that debt of the mortgage guarantors means that remaining spreads on the securities have nothing to do with their creditworthiness, said Jim Vogel, an agency debt analyst at FTN Financial. The U.S. has been forcing the firms to contract their portfolios at a 10 percent annual pace, a rate increased this month to 15 percent.
“The market is small enough now that there are enough buyers who don’t care,” Vogel said. Instead, yield premiums stem from items such as how it’s easier to trade Treasuries and how investors are slow to change their habits, he said.
In the mortgage-bond market, the pricing advantage with Ginnie Mae’s $1 trillion of securities may be poised to shrink as the adjusted bailout terms for Fannie Mae and Freddie Mac draw new investors over time to their $4 trillion of notes, Barclays analysts led by Nicholas Strand wrote in an Aug. 17 report.
“The government is signaling what most market participants already know: Fannie Mae and Freddie Mac are essentially off-balance-sheet government entities,” they said. On whether skeptical investors, who are “typically overseas,” will change their minds, the answer is “an unambiguous ‘yes,’” they said.
Morgan Stanley analysts Vipul Jain and Janaki Rao disagree.
While the reworked agreements should be enough to remove “any lingering doubts regarding the financial” strength of the companies, the behavior of banks and overseas investors are “unlikely to change,” they wrote in an Aug. 17 report.
Any shift that draws other investors toward Fannie Mae and Freddie Mac mortgage securities from Ginnie Mae bonds could raise the relative costs of loans insured by the Federal Housing Administration and Department of Veterans Affairs, which offer greater underwriting flexibility for home buyers with low down payments.
Ginnie Mae securities mainly package those mortgages, while Fannie Mae and Freddie Mac bonds finance conventional loans. Their relative prices also reflect differences in how fast and predictably the notes get repaid as homeowners refinance, sell properties and default. Lenders respond to changes in the debt’s values by varying loans rates, their profit margins or both.