US Agency Market 2010 and Beyond
California Municipal Treasurers AssociationApril 21, 2010
The materials may not be used or relied upon in any way.
CONFIDENTIAL
Ivan Hrazdira, Managing Director
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Fannie Mae:Total Debt Outstanding: $785.8bn as of Feb 28, 2010Total Long Term Debt Outstanding: $581.6Total Long Term Issuance: $52.4Total Net Long Term Issuance: ($3.5)
Freddie Mac:Total Debt Outstanding: $833.3bn as of Mar 31, 2010Total Long Term Debt Outstanding: $596.2Total Long Term Issuance: $111.2Total Net Long Term Issuance: $16.9
FHLB:Total Debt Outstanding: $870.9bn as of Mar 31, 2010Total Long Term Debt Outstanding: $682.7Total Long Term Issuance: $148.4Total Net Long Term Issuance: ($49.4)
Farm Credit: Total Debt Outstanding: $173.3bn as of Mar 31, 2010Total Long Term Debt Outstanding: $163.8Total Long Term Issuance: $24.5Total Net Long Term Issuance: ($0.7)
Agency Market Stats
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Pro:
Sidelined overseas investors have returned to the market
Relatively low global rates will make spread product appealing
Government has stressed a solid backing of the GSE credit
through PSPA
Our base case scenario is for swap spreads to tighten
Con:
GSE Supply in short term will be higher than the market was
anticipating
“Legislative orphans”
Higher rates may bring in convexity paying in swaps
Our Outlook on Spreads
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Preferred Stock Purchase Agreement
Preferred Stock Purchase Agreement
The mechanism whereby the US government backstops the debt and mortgages of Fannie Mae and Freddie Mac
Announced on Sept 7th, 2008. Is part of conservatorship“Treasury and FHFA have established Preferred Stock Purchase Agreements, contractual agreements between Treasury and the conserved entities. Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and stability to GSE debt holders – senior and subordinated – and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities.”
Initial amounts were $100bn each; later increased to $200bn each.
So far, Fannie Mae has drawn on $76bn and Freddie Mac has drawn $51bn. Freddie Mac has not drawn any capital for two quarters.
0
20
40
60
80
100
Liabilities Assets0
20
40
60
80
100
Liabilities Assets
IF:
> (incl. principal and interest payments)
Then:
Government injects amount of capital to make up for shortfall
New injection takes form of preferred stock, which pays the government a 10% dividend
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“Under the Agreements, following a payment default by a GSE with respect to any Holders, and in the event Treasury fails to perform its obligations to either of the GSEs in respect of any draw on the Commitments, those Holders may file claims in the United States Court of Federal Claims for relief requiring Treasury to pay the relevant GSE a specified amount (called "the Demand Amount") in the form of liquidated damages. After consultation with the Civil Division of the Department of Justice, we conclude that the United States Court of Federal Claims generally would have jurisdiction under the Tucker Act to entertain claims brought by the Holders for liquidated damages, payable to a GSE, according to the terms of the Agreements, if Treasury failed to perform its obligation under the Agreements to fund the Commitment in the event of a payment default by the GSE to the Holders”
Department of Justice Ruling on PSPA
Source: US Department of Justice Office of Legal Counsel – Letter from the DOJ to
Treasury
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Among non-US accounts, strong opinions on FHLB
Europe vs. Asia vs. Asia
Among US investors, FHLB / Fannie / Freddie are fungible
What drives a customers decision to buy a particular name?
Flexibility
Cost
Tax Advantage
Liquidity
The Future
Investor Behaviour
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Changes in Investor Participation
1915 19
16 3224 29
31 2135
1726
0
20
40
60
80
100
120
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
0
500
1000
1500
2000
2500
3000
3500
US Asia Europe Other Federal Agency Securities
Source: Fannie Mae
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Lessons Learned:
Loose underwriting led to the housing debacle
ARMs created more problems than they solved
Excessive leverage prevented the GSEs from being effective backstops
Implicit guarantee and conflicting mandates encouraged GSE risk taking
New entities must have robust capital standards/leverage ratio limits to minimize systemic risk
What will happen to mortgage finance now?
What the Government will now want:
An appropriately functioning three tiered system to service all homeowners:
FHA for lower income
GSEs/successors for lower/middle income
Private label for jumbo mortgages
Protect the taxpayer
Support 30yr fixed rate mortgage and TBA market
Make implicit guarantee explicit in a cost effective way
Require GSEs to be overcapitalized to not only withstand loss but also operate even after a catastrophic loss
A model that is more sustainable than the Fed b/s
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FNMA & FHLMC
FNMA FHLMC
FHLMCFNMA
Currently:
2010:
2011 and Beyond:
New World:
• Covered Bonds
• Little or no government involvement
• Fannie/Freddie wound down
Government Guaranteed
• An entity backed by the government in the business of packaging MBS that meet certain criteria; broader FHA
Successor Entities Providing
Guarantees • Hybrid ownership
• Utility model regulated returns
•Private Capital, with government providing catastrophic loss backstop
AS IS
Probability: Low Medium HighLow
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Will very likely remain in some form as part of the new structure of mortgage finance. Here’s Why: Know how and technology The ability to act as a buyer of last resort The entrenched, efficient nature of the TBA market
Biggest question is what will happen to the portfolios? Very contentious issue Not the cause of huge losses Any future role for portfolios would have to be mission consistent and meet
funding hurdles
In almost any scenario, the portfolios will shrink significantly
What will happen to Fannie and Freddie
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The dissolution of Fannie and Freddie
Implicit vs. Explicit
The rise of Supras and Sovereigns
Covered Bonds
Libor spike
“FDIC Risk”
Removal of Superlien
Taxing FHLB System
Threats to FHLB Market
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What’s the Outlook for Agency Supply?
Source: Companies and/or their websites
Net Issuance (long term debt)
146
48
438
1231
0
69
14
-41 -39-18
36
105
5618
-1
-78 -75
242
180
76
-63-45
-12
-60-26-42
153527
60 3763 53
123
-200
-150
-100
-50
0
50
100
150
200
250
300
Freddie Fannie FHLB Total
2002 2003 2004 2005 2006 2007 2008 2009 2010 projected
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The Supra/Sov Market
$0
$50,000
$100,000
$150,000
$200,000
$250,000
$300,000
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010Prorata
0
20
40
60
80
100
120
140
160
180
200
Deal Value $ (Face) (m) No.
Deal Value $ # of Deals
Source: Credit Suisse
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Trades We Like – Fixed to Float
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Fixed to Float Trades
0
1
2
3
4
5
0 1 2 3 4 5Years
Rat
e (%
)
3-month Libor Fwd Curve
1yr Fixed @ 1% w/ 5% Cap
This is a hypothetical bond with a 1% coupon for a year, that converts to floater thereafter at 3ML+50
Bond is callable quarterly after first 3 months
This graph reflects hypothetical returns if forwards are met
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Various outcomes for Fixed - Float: A Simplistic AnalysisWhat Happens Result Comparable
Inv.P/L
Bond gets called in 3 months
Bond gets called in 1year
Bond does not get called
Bond does not get called and hits the cap
Make 1% for 3 months
Make 1% for 1 year
Make 1% for 1yr, then L+50 until call or maturity
Make 1% for 1yr then L+50, capped at 5%
Discount Note at 0.18%
One year bullets yield 0.58%
5yr floater issued by GSEs would likely yield about L+10
5yr floater issued by GSEs would likely yield about L+10
Outperform alternative
Outperform alternative
Outperform alternative
Underperform alternative
These outcomes are not conclusive but are broadly representative. There are many possible outcomes
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Investors interest in agencies remains robust
However, the future is highly uncertain
Although legislative change will come slowly, it will
happen
Alternatives to GSE market are real
Great trades out there to take advantage of Fed forecasts
Key Takeaways