Bloomberg.com: News

Bloomberg.com: News: "Fannie Mae Pays Record Spreads on Two-Year Note Sale (Update3)

By Dawn Kopecki and Bryan Keogh
Enlarge Image/Details

Fannie Mae Pays Record Spreads on Two-Year Note Sale (Update3)

By Dawn Kopecki and Bryan Keogh
Enlarge Image/Details

July 9 (Bloomberg) -- Fannie Mae paid a record yield over benchmark rates on $3 billion of two-year notes amid concern that the U.S. mortgage-finance company doesn't have enough capital to weather the biggest housing slump since the Great Depression.

The 3.25 percent benchmark notes priced to yield 3.27 percent, or 74 basis points more than comparable U.S. Treasuries, the Washington-based company said today in an e-mailed statement. That's the biggest spread since Fannie Mae first sold two-year benchmark notes in 2000 and triple what it paid in June 2006.

Investors and traders are overlooking the government's implied guarantee of Fannie Mae and Freddie Mac debt as credit losses grow. The companies have raised more than $20 billion since December as their combined losses grew to more than $11 billion. Credit-default swaps tied to their $1.45 trillion of AAA rated debt are trading at levels that imply the bonds should be rated A2 by Moody's Investors Service, according to data compiled by the firm's credit strategy group.

``There's tremendous fears in these two,'' said Andrew Brenner, co-head of structured products and emerging markets in New York at MF Global Inc. ``Look how they're trading in credit- default swap land.''

In the stock market, Freddie Mac dropped $3.20, or 24 percent, to $10.26 in New York. Fannie Mae fell $2.31, or 13 percent, to $15.31. Both are down more than 60 percent so far this year.

Swaps Market

Jason Lobo, a Fannie Mae spokesman, declined to comment on the debt sale. Fannie Mae last month sold $4 billion of 3 percent benchmark notes maturing in 2010 that priced to yield 3.036 percent, or 65 basis points more than U.S. Treasuries of similar maturity. A basis point is 0.01 percentage point.

Bank of America Corp., Merrill Lynch & Co. and JPMorgan Chase & Co. managed the sale. Benchmark notes are Fannie Mae's largest type of debt issue, with a minimum size of $3 billion.

Fannie Mae's spread relative to interest-rate swaps are not at their widest ever, said Jim Vogel, the head of agency debt research at FTN Financial Group in Memphis, Tennessee.

``That will explain 80 to 90 percent of what's going on in agency spreads at the short-term part of the market right now,'' Vogel said. ``The swaps market is large and liquid and not necessarily concerned specifically with Fannie and Freddie on any given day.''

`Troublesome'

Congress created Fannie Mae and McLean, Virginia-based Freddie Mac to promote home buying in the U.S. The companies' congressional charters provide exemption from state and local corporate income taxes and give the Treasury the authority to buy as much as $2.25 billion in each of their securities in the event of possible default.

``Investors are viewing even an implicit guarantee from the government as potentially troublesome,'' said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California. Fannie Mae and Freddie Mac.

Concerns that Fannie Mae and Freddie Mac may need more capital were heightened this week after Lehman Brothers Holdings Inc. released a report saying a new accounting rule may require the companies to raise $75 billion.

Agency Spreads

Yields on agency mortgage securities relative to U.S. Treasuries climbed toward the 22-year high reached in March amid concern that financial companies including Bank of America and Fannie Mae may need to sell the debt.

Fannie Mae in June 2006 sold $4 billion of two-year notes at a spread of 26.5 basis points, Bloomberg data show.

The price of contracts used to speculate on the creditworthiness of Fannie Mae and Freddie Mac and to protect against a default doubled in the past two months.

Credit-default swaps tied to senior debt of Fannie Mae and Freddie Mac have climbed to 80.5 basis points and 80 basis points from 35 basis points on May 1, according to London-based CMA Datavision.

The cost to protect the companies' subordinated debt from default rose at a faster rate. That debt is rated Aa2 by Moody's. Credit-default swaps on Fannie Mae's subordinated notes has jumped 133 basis points to 190 basis points since May 1, while contracts on Freddie Mac's rose 132 basis points to 220 basis points.

`Constructive Force'

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline, the opposite. A basis point on a contract protecting $10 million of debt for five years is equivalent to $1,000 a year.

``It concerns me that people sort of extrapolate well beyond what the facts are,'' James Lockhart, the director of the Office of Federal Housing Enterprise Oversight, said in an interview with Bloomberg Television yesterday.

Treasury Secretary Henry Paulson said yesterday that the companies can still be a ``constructive force'' in the economy.

The government is leaning on the companies to help revive the home-loan market. Congress lifted growth restrictions on the companies, eased their capital requirements and allowed them to buy bigger, so-called jumbo mortgages to spur demand for home loans as competitors fled the market.

Very Expensive

The decision to use Fannie Mae and Freddie Mac as part of a $300 billion housing stimulus plan strengthens perceptions of the government's support of the companies, S&P said in May.

Their share of new conforming mortgages, or loans of $417,000 or less, almost doubled to 81 percent in the first quarter, Ofheo said.

Merrill Lynch & Co. analyst Kenneth Bruce said in a report yesterday the ``highly levered financial institutions'' will have pretax credit-related losses of $45 billion.

``Fannie and Freddie are going to have to raise more capital and nobody thinks they're going to be able to raise capital when they need to,'' said Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia. ``It's going to be very expensive.''

To contact the reporters on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net; Bryan Keogh in New York at bkeogh4@bloomberg.net
Last Updated: July 9, 2008 18:25 EDT