Agency spreads mostly flat; callables busy; Fannie Mae reopens five-years, offers two-years

By Kenneth Lim

Boston, Dec. 2 - Agency callable issuance shot through the roof on Wednesday while Fannie Mae did its part on the bullet end with two deals.

Bullet spreads in general were flattish with two-year spreads out by about 1 basis point, said Doug Matthius, an agency trader at Southwest Securities.

Freddie Mac's new 1.375% three-year Reference Notes, which priced Tuesday, were unchanged at a spread of 31 bps.

"As far as bullets, I think they just came and went," he said. "They're dramatically unchanged from yesterday."

Most of the action was on the callable side of the market, Matthius said.

"It was definitely one of our busiest days in a long, long time," he said.

Callable surge

Callable issuance spiked on Wednesday as risk-averse investors sought out short-term yields, Matthius said.

"It was probably one of the biggest production days we've had in a long, long time," he said. There was "record underwriting. The soup du jour has been step-ups. It's been a very defensive market."

The issuance was sparked in part by a break in the Treasury market's recent strength, he added.

"I think it's the first day in a while that the Treasury market has given up climbing," he said.

Investors who want to maintain a low risk profile in their portfolios but nevertheless want better yields are looking for the callable step-ups, which offer better returns initially and can potentially yield more if they are not called in the future.

"Accounts are getting very defensive, buying coupons that are substantially better than money markets or one- or two-year bullets," Matthius said. "These will definitely outperform in the short term."

John W. Young, managing director of agencies at Hapoalim Securities, said he was surprised at the "sheer volume" of callables issued on Wednesday.

"We were a little surprised," he said.

The agencies were "pretty much running the gamut" in terms of the type of structures offered, but short-term callables were the most popular, he said.

He attributed some of the demand to year-end pressure.

"I think there's a lot of year-end cleaning," Young said. "A lot of accounts [are] putting money to work...coming into the home stretch."

Persistent demand

Young did not think that the reasons for the strong issuance would disappear and expects the strong callable demand to last until at least the end of the month.

Matthius said issuance could abate slightly on Thursday as the market awaits Friday's non-farm payroll numbers. But issuance could pick up again if Treasuries show new weakness.

"To me the Treasury market has to give," he said. "It's way too strong, taking record issuance in stride and never looking back."

Fannie adds to supply

Fannie Mae ensured that not all the primary market action was in callables, reopening an existing five-year series on Wednesday and offering new two-years for Thursday.

Fannie Mae priced a $1 billion reopening of its 2.625% five-year Benchmark Notes to yield 2.25%.

The notes were sold at 101.751 through an auction.

There was $3.5 billion of outstanding notes under the series before the reopening.

The five-years ended unchanged, Matthius said.

Fannie Mae also announced a new offering of two-year Benchmark Notes for Thursday. Price talk is at a spread of 24.5 bps over Treasuries, market sources said.

The size has not been set, but the amount is expected to be at least $3 billion.

Citigroup Global Markets Inc., J.P. Morgan Securities Inc. and Morgan Stanley & Co. are the lead managers.

The Fannie Mae announcement was a surprise for the market, which had been expecting a new issuance in the short end of the yield curve or a reopening in the five-year sector, but not both.

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