Agency spreads narrow on Greece deal, Fed action; Fannie Mae's short-term debt needs eyed

By Kenneth Lim

Boston, Feb. 11 - Agency spreads tightened slightly on Thursday in line with the broader credit markets as E.U. officials agreed to support debt-heavy Greece.

The Federal Reserve Bank of New York also provided support at the front end of the yield curve through a purchase operation, although overall trading volumes remained thin on expectations of a range-bound outlook.

News that Fannie Mae and Freddie Mac will begin to buy back delinquent loans had a muted impact on agency debt, although Fannie Mae may need to raise more short-term funding to pay for the buybacks.

Agency spreads were about 0.5 to 1 basis point tighter on Thursday, with two-years performing slightly better on the Fed buying, an agency trader said.

"Spreads are slightly narrower," the trader said. "The E.U. said it's going to help Greece, so that took a load off of spreads across the board. We didn't tighten as much as the supra-sovereigns, but at the same time we were not as affected when the problem first came up, so we won't be as affected as the problem goes away."

Callable issuance remained lackluster in line with overall sluggishness in the market, although Freddie Mac priced $1 billion of zero-coupon 25-year non-call one-year medium-term notes at 24, according to the agency's web site.

The bonds will mature on March 2, 2035 and have a Bermuda call beginning March 2, 2011.

Goldman Sachs was the manager.

Weak volumes

Scott Graham, head of U.S. government agency trading at RBS Securities, said trading activity was lacking as investors appeared to be more concerned about the Greece situation and Treasury supply. The Treasury on Thursday completed the week's $81 billion of auctions with a sale of 30-year bonds.

"We're kind of in a range-bound trade where people are focusing more on Treasury supply, people focusing more on what's going on overseas," Graham said. "With swap rates where they are, there's not a very compelling trade to go wider or narrower, and it just makes for kind of a lackluster environment."

The market did get some support on Thursday from the Fed, which bought $1.349 billion of one- to two-year agency notes from the open market. The amount purchased was 30% of the $4.499 billion offered, and targeted paper due February 2011 to January 2012.

"The Fed purchases were as expected," Graham said. "But it's a much slower takeup rate than before."

Fannie Mae to issue more

Fannie Mae may need to raise more short-term funding in order to pay for delinquent loans that it plans to buy up, said Guy LeBas, chief fixed income strategist at Janney Montgomery Scott.

Fannie Mae and Freddie Mac on Wednesday said they will buy back at par about $200 billion of home loans that are at least four months in arrears. Freddie Mac plans to buy back about $70 billion of such loans by March, while Fannie Mae expects to buy up $127 billion of such loans beginning in March.

The news "blew out mortgage spreads" on Wednesday as holders of affected mortgage-backed securities dealt with the news, but agency debt was largely insulated, LeBas said.

"It's not all that meaningful for the agencies' balance sheets themselves," he said. "It's more meaningful for the holder of the mortgage-backed securities."

One implication of the announcements is that Fannie Mae will probably have to raise more short-term funding to finance the buybacks. Freddie Mac has "actually been building funding over the last couple of weeks," LeBas said.

"They've issued more in discount notes," he said. "It looks like they're quite well covered."

Fannie Mae, however, has been "a little behind the eight ball."

"At least if Freddie Mac is a model, they're going to have to raise funding, and they're probably going to raise short-term funding," LeBas said.

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