Agencies tighten as Obama administration reveals plan to wind down Fannie Mae, Freddie Mac

By Kenneth Lim

Boston, Feb. 11 - Agency spreads narrowed on Friday following a supportive paper by the Obama administration that emphasized a commitment to existing Fannie Mae and Freddie Mac debt while laying out plans to wind down the two government sponsored enterprises.

Bullet spreads narrowed by about 2 basis points in the three-year sector and by about 3 bps in the five-year region, a trader said.

"We've been tightening into the announcement, and the white paper only reinforced the trend toward smaller issues, smaller portfolios and therefore less debt," the trader said.

Volumes, however, were muted, as they have been for most of the week.

"I think it was just a culmination of a long week for everybody," the trader said, referring to the persistent climb of absolute rate levels.

There may also have been a measure of yield hunting behind Friday's narrowing spreads.

"I think more so than the paper driving spreads has been the backup in yields," the trader said. "I think you'll continue to see rate buyers drawn into the market. I personally expected us to be lower in yields today, but we're walking out higher in yields, obviously because of the [Egypt president Hosni Mubarak] resignation."

Fannie Mae, Freddie Mac eyed

The White House on Friday said it plans to wind down Fannie Mae and Freddie Mac and offered Congress three proposals for the government's long-term role in the housing finance market.

The first option will be to essentially end all government guarantees and insurance for mortgages except for limited programs aimed at creditworthy lower- and moderate-income borrowers, according to a paper by the Treasury and the Housing and Urban Development departments that was presented to Congress.

The second option will involve the government also offering a minimal "backstop mechanism" - such as a guarantee fee - that can be scaled up in times of financial stress so that borrowers can still have access to capital.

The final option is closest to status quo, with the government offering a backstop, possibly through reinsurance for private mortgage guarantor companies that meet certain capital requirements.

In general, the options all aim to leave the bulk of mortgage financing to the private sector. The more presence that the government has in the market, the more effective it would be in keeping credit accessible. But the trade off is a greater risk of market distortion, the paper said.

The paper stopped short of endorsing any of the proposals, saying only that the administration will continue to seek feedback on which option will work best.

Existing agency investors were also heartened by a statement of support in the paper for existing obligations of Fannie Mae and Freddie Mac.

"The government is committed to ensuring that Fannie Mae and Freddie Mac have sufficient capital to perform under any guarantees issued now or in the future and the ability to meet any of their debt obligations," the paper stated. "The administration will not pursue policies or reforms in a way that would impair the ability of Fannie Mae and Freddie Mac to honor their obligations."

Subordinated debt tightens

Joseph J. Riley, senior managing director of institutional sales and trading at Mesirow Financial, said the strong commitment to existing Fannie Mae and Freddie Mac debt helped the market to tighten on Friday.

"The most dramatic tightening is in sub debt," he said. "Sub debt stuff is screaming in."

The other trader said the banks could now be more aggressive in pushing for covered bonds to replace the role of agencies.

"Banks are trying to position themselves to try and take over the mortgage market," the trader said. "I do think they're going to make a push and try to increase the covered bond program to try and supplant some of the debt issuance...they're trying to do that, but if you can introduce some type of government type backing there could be an active market."

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