Agencies flat, three-years widen as FHLB eyes $3 billion deal; order book fills up early

By Kenneth Lim

Boston, April 13 - Agency spreads closed mostly flat on Wednesday, with the three-year sector widening out slightly after Federal Home Loan Banks announced a $3 billion offering.

Bullet spreads in general closed the day unchanged, maintaining the market's recent tights.

"Five-year spreads are basically unchanged to a half point tighter," an agency trader said.

The callable market saw slightly better activity, with investors looking mostly at callable step-up structures.

"You're really seeing a proliferation of step-up type structures - the types of deals that are getting to the smaller, regional retail investors," the trader said.

Most of the callable offerings were in the three- to seven-year sectors, and a search for yield has been driving demand.

"One thing that's symptomatic of quantitative easing is that because of a search for yields, accounts are moving from straight callables into callable step-ups and into structured products," the trader said.

Secondary trading activity was focused on the three-year sector on the back of FHLB's new deal.

"The Home Loan three-year today was pretty much the center of attention on this desk," the trader said.

FHLB plans three-years

FHLB plans to price $3 billion of three-year Global Notes on Thursday, talked at a tightened spread of 18.5 basis points over Treasuries, market sources said.

Price talk was initially set at a spread of 19 bps over Treasuries.

Barclays Capital Inc., Goldman Sachs & Co. and J.P. Morgan Securities LLC are the lead managers.

The deal saw strong demand right from the start, with the order book filling up in the morning.

"The deal was oversubscribed," the trader said. "We saw good demand here, given the size of the deal and the fact that it was oversold...It was $3 billion as of late this morning, and I have to believe it's upward of $4 billion or so going out this afternoon."

But the trader said FHLB is not expected to increase the size of the deal, keeping in line with the agency's preference to stick with its original funding plan. The Street was likewise conservative in building up the order book, "so as not to accept more orders than they necessarily need," the trader added.

"They announced $3 billion, and they're sticking to $3 billion," the trader said.

Price talk was only a slight concession to surrounding issues, but demand seemed robust. One concern was that the May 28 maturity of the notes pushed it just a little over three years, which could lead some investors to demand a cheaper deal, the trader said.

FHLB could also tighten pricing in light of the strong demand during marketing, which could dampen the notes' performance in the secondary market.

"The wild card is Home Loans sometimes has a tendency to come with a spread that's attractive, then over the course of the marketing period they'll tighten it," the trader said. "In this case it could be justified because swaps tightened in by about half a point today."

Street gets sector correct

The trader said that despite the slight widening in three-years on Wednesday, the market had rightly guessed that FHLB would target the sector.

The only surprise was that some segments of the market thought that the agency could skip the issuance date.

"I think the Street had the sector pegged if they did come," the trader said.

The trader expected the deal to do well on Thursday.

"We saw very good demand here," the trader said.

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