High redemptions, low interest rates drive callable issuance higher in first half, Fannie Mae says

By Kenneth Lim

Boston, July 27 - Heavy redemptions and a low interest-rate environment drove Fannie Mae callable issuance up 30% year-over-year in the first half of 2010, the agency reported Tuesday.

Fannie Mae issued about $149.1 billion of callable paper in the first six months of the year, representing about 73.5% of its total $202.8 billion in debt issuance for the period.

Fixed-rate notes formed 62.9% of the callables issued by Fannie Mae in the first half, followed by step-up notes, which made up 31.2% of the callable issuance volume. Zero-coupons were 4.1% of new callable debt.

Fannie Mae also reintroduced step-down callables in April, which allows investors to structure coupons that adjust downward at a fixed schedule. Such structures represented 0.1% of the agency's first-half callable issuance.

Step-up issuance nearly tripled year-over-year, reflecting fears that interest rates will eventually increase. Zero-coupon callables also remained in demand, with 25- to 30-year maturities that are non-callable for six months to two years the most popular structure.

"Callable activity was particularly robust in the months of April and June 2010, when the market experienced a rally in long-term rates and concerns over European sovereign risk may have led investors to invest in long-term agency securities that typically offer higher yield than comparable Treasuries," Fannie Mae stated in its report.

"Furthermore, Fannie Mae sought to replace the high volume of callable redemptions of approximately $126 billion during the first half of 2010 to offset the inherent negative convexity and volatility exposure in its mortgage portfolio."

The Fannie Mae data is similar to storylines at the other agencies. Freddie Mac issued $124.4 billion of medium-term callables in the first half of 2010, up by 3.6% year-over-year, while Federal Home Loan Banks issued $111.5 billion of fixed-rate callables in the first two quarters, according to data from both agencies.

Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott, said the increase in callable issuance has not come at the expense of other debt structures because overall issuance has increased. Total year-to-date agency issuance is about $730 billion as of Tuesday, compared with about $645 billion a year ago, he said.

Demand for step-ups has actually declined slightly as fears of higher interest rates eased with new economic uncertainties.

"They've gotten a tad out of fashion," he said.

LeBas expects callable demand to still be strong, although the second half of the year could see a slight slowdown because most maturity dates occur mid-year.

"Their maturity schedules, other than June and July, isn't that big," he said. "But they do have a lot of older callable coupons that are hitting their first call dates. ... Their funding needs are driven by calls of outstanding issues rather than demand for new issues or balance sheets."

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