Fannie Mae and Freddie Mac's success in repaying $223 billion of bonds due by the end of the quarter may determine whether they can avoid a federal bailout.
Fannie, based in Washington, has about $120 billion of debt maturing through Sept 30, while McLean, Virginia-based Freddie has $103 billion, according to figures provided by the government-chartered companies and data compiled by Bloomberg.
Rising borrowing costs and evidence that demand for their debt was waning last month led Treasury Secretary Henry Paulson to seek the authority to pump unlimited amounts of capital in Fannie and Freddie in an emergency. Their interest costs are again increasing amid concern that credit losses are depleting the capital of the beleaguered mortgage-finance companies.
Rolling over the debt “is the single most important factor to their ability to remain liquid,” said Moshe Orenbuch, an analyst at Credit Suisse in New York. “So far, they've been able to do that.”
Investors in Asia, the biggest foreign owner of Fannie's $3 trillion of bonds, are reducing their share of purchases, potentially increasing the need for Paulson to make good on his pledge to backstop the companies.
“This whole backstop mechanism was set up so the actual need for it could be avoided,” said Mahesh Swaminathan, a mortgage strategist for Credit Suisse in New York. “The market is testing the Treasury's resolve.”
New Capital: The companies, responsible for 42 per cent of the US home loan market, need as much as $15 billion each in fresh capital to reserve against losses on mortgages and related securities that they either own or guarantee, Paul Miller, an analyst with Friedman Billings Ramsey & Co in Arlington, Virginia, said.
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The Treasury will probably be forced to buy as much as $30 billion of preferred shares in both Fannie and Freddie by the end of next month, according to Bill Gross, who manages the world's biggest bond fund at Pacific Investment Management Co.
“Treasury is monitoring market developments vigilantly. We are focused on encouraging market stability, mortgage availability, and protecting the taxpayers' interests,” Treasury spokeswoman Jennifer Zuccarelli said.
Freddie Mac “continues to have strong access to the debt markets at attractive spreads,” spokeswoman Sharon McHale said. Fannie spokesman Brian Faith declined to comment.
Losing Faith: Investors this week demanded an extra 104 basis points in yield to own Freddie's five-year debt rather than Treasuries of similar maturity, the most since reaching a 10-year high of 114 basis points in March. The gap narrowed to 74 basis points after Paulson's announcement. A basis point is 0.01 percentage point.
Fannie spreads approached a 10-year high of 104 basis points on Aug. 18, from 74 basis points on July 28. In the decade before 2008, the spread averaged 43 basis points.
“The fixed-income markets are starting to lose faith,” Miller said.
JPMorgan Asset Management Japan is reducing its holdings of Fannie and Freddie debt, according to Shinji Kunibe, a senior money manager at the firm in Tokyo. And Yuuki Sakurai, the general manager of financial and investment planning in Tokyo at Fukoku Mutual Life Insurance Co., said his firm is also “a little bit worried about the fate of” Fannie and Freddie.
“The conditions don't seem to be turning into a good environment,” Sakurai said.
Fannie fell 14 cents to a 19-year low of $6.01 yesterday in New York Stock Exchange trading. Freddie was at its lowest level since January 1991, dropping 22 cents yesterday to $4.17. Both have tumbled more than 90 per cent in the past year. In European trading today, Fannie climbed 15 cents to $6.16 by 11 a.m. in Frankfurt, and Freddie added 13 cents to $4.30.
Highlighting Problems: Fannie's market value has shrunk to $6.47 billion and Freddie's declined to $2.7 billion, making it increasingly difficult for the companies to raise equity through public markets, Miller said. The companies have reported a combined $14.9 billion of net losses the past four quarters.
After receiving authority last month to inject unlimited capital into Fannie and Freddie, a Treasury spokeswoman this week said Paulson had no plans to use his new power.
Initial optimism that Paulson's proposal would bolster confidence in the companies has vanished on concern that the deteriorating housing market may force a bailout, a move that would likely wipe out common shareholders and potentially some preferred stockholders, Miller said.
“It hasn't restored any faith, it just highlighted their problems,” Miller said. “The market has come to accept the fact that the government has got to do something.”
Freddie's 5.57 per cent perpetual preferred shares are trading at $9.37 to yield 15.3 per cent, compared with $17.99 and a yield of 7.77 per cent on June 30 before the crisis erupted. Fannie's 5.5 per cent preferred shares yield 16.4 per cent, up from 7.83 per cent on June 30.
Roosevelt's Creation: Fannie was created as part of Franklin D. Roosevelt's New Deal in the 1930s and became a publicly owned company in 1968. Freddie was started in 1970 during the Vietnam War, primarily as competition for Fannie.
The companies, which own or guarantee about $5 trillion of the $12 trillion of outstanding US home loans, help expand financing to homebuyers by purchasing home loans from lenders and packaging other loans into securities that they then guarantee.
The companies, which have a combined $1.7 trillion in outstanding unsecured debt, issue new debt to pay off outstanding obligations as they mature. The companies can also sell securities to raise cash.
‘Aggressive’: “While the plan was extraordinarily aggressive, it seems that the market is looking for something even more explicit and more guidance about what form that will take,” said Margaret Kerins, the managing director of agency debt strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut.
Freddie had $70 billion of cash and non-mortgage investments on June 30 and $470 billion of agency mortgage securities that it could pledge for secured borrowing, the company said Aug 6.
Fannie paid a record high yield in a $3.5 billion sale of three-year benchmark notes last week that drew less demand from Asia. Investors in the region bought 22 per cent of the offering, almost half the demand of three months ago and about two-thirds of Asia's usual purchases.
“The 22 per cent of Asian participation is worrying,” said Ajay Rajadhyaksha, the head of fixed-income strategy for Barclays Capital in New York.
Freddie's latest auction of short-term notes attracted less interest from investors for the second straight week.
Freddie this week said it sold $4 billion of short-term notes in a weekly auction, where investors bid for 2.19 times the amount of three-month securities available, down from 2.73 times last week. The bid-to-cover ratio on the company's six- month securities was 2.42 times, down from 2.92 times, while the ratio on 12-month debt sold was fell to 1.75 times, from 2.50.