Transcript CONFIDENTIAL US Agency Market 2010 and Beyond California Municipal Treasurers Association April 21, 2010 Ivan Hrazdira, Managing Director The materials may not be used or relied.

CONFIDENTIAL
US Agency Market
2010 and Beyond
California Municipal Treasurers Association
April 21, 2010
Ivan Hrazdira, Managing Director
The materials may not be used or relied upon in any way.
Agency Market Stats
Fannie Mae:
Total Debt Outstanding:
Total Long Term Debt Outstanding:
Total Long Term Issuance:
Total Net Long Term Issuance:
$785.8bn as of Feb 28, 2010
$581.6
$52.4
($3.5)
Freddie Mac:
Total Debt Outstanding:
Total Long Term Debt Outstanding:
Total Long Term Issuance:
Total Net Long Term Issuance:
$833.3bn as of Mar 31, 2010
$596.2
$111.2
$16.9
FHLB:
Total Debt Outstanding:
Total Long Term Debt Outstanding:
Total Long Term Issuance:
Total Net Long Term Issuance:
$870.9bn as of Mar 31, 2010
$682.7
$148.4
($49.4)
Farm Credit:
Total Debt Outstanding:
Total Long Term Debt Outstanding:
Total Long Term Issuance:
Total Net Long Term Issuance:
$173.3bn as of Mar 31, 2010
$163.8
$24.5
($0.7)
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Our Outlook on Spreads
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
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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.
IF:
100
Then:
80
80
60
60
40
40
20
20
0
Liabilities
>
Government injects
amount of capital to
make up for
shortfall
100
0
Assets
Liabilities
Assets
(incl. principal and interest
payments)
New injection takes form of preferred stock,
which pays the government a 10% dividend
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Department of Justice Ruling on PSPA
“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”
Source: US Department of Justice Office of Legal
Counsel – Letter from the DOJ to Treasury
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Investor Behaviour
 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
5
Changes in Investor Participation
120
3500
3000
100
15
80
19
19
16
24
32
29
31
21
35
2500
17
26
2000
60
1500
40
1000
20
500
0
0
1999
2000
2001
2002
US
Asia
2003
2004
Europe
2005
Other
2006
2007
2008
2009
2010
Federal Agency Securities
Source: Fannie Mae
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What will happen to mortgage finance now?
Lessons Learned:
What the Government will now want:
 Loose underwriting led to the housing debacle
 An appropriately functioning three tiered system to
service all homeowners:
 ARMs created more problems than they solved
 FHA for lower income
 Excessive leverage prevented the GSEs from being
effective backstops
 Implicit guarantee and conflicting mandates
encouraged GSE risk taking
 GSEs/successors for lower/middle income
 Private label for jumbo mortgages
 Protect the taxpayer
 New entities must have robust capital
standards/leverage ratio limits to minimize systemic
risk
 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
Currently:
FNMA
FHLMC
2010:
FNMA
FHLMC
New World:
2011 and
Beyond:
• Covered Bonds
AS IS
Low
• An entity backed by the
• Little or no government government in the business
of packaging MBS that meet
involvement
• Fannie/Freddie wound
down
Probability:
Government
Guaranteed
Low
Successor Entities
Providing Guarantees
• Hybrid ownership
• Utility model regulated returns
certain criteria; broader FHA •Private Capital, with
government providing
catastrophic loss backstop
Medium
High
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What will happen to Fannie and Freddie
 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
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Threats to FHLB Market
 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
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What’s the Outlook for Agency Supply?
Net Issuance (long term debt)
300
250
200
150
100
242
180
146
105
60
36
48
69 63
4 14
50
0
-50
123
56
38
76
53
12
27
37
-42 -39
-41
-100
-150
31 35
18
-1
-26 -18
-63
0
15
-12
-45
-78
-75
-60
-200
Freddie
2002
2003
2004
2005
Fannie
FHLB
2006
Total
2007
2008
2009
2010
projected
Source: Companies and/or their websites
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The Supra/Sov Market
Deal Value $
# of Deals
$300,000
200
180
$250,000
160
140
$200,000
120
$150,000
100
80
$100,000
60
40
$50,000
20
$0
0
2000
2001
2002
2003
2004
2005
2006
Deal Value $ (Face) (m)
2007
2008
2009
2010
Prorata
No.
Source: Credit Suisse
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Trades We Like – Fixed to Float
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Fixed to Float Trades
 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
5
Rate (%)
4
3
2
3-month Libor Fwd Curve
1yr Fixed @ 1% w/ 5% Cap
1
0
0
1
2
3
4
5
Years
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Various outcomes for Fixed - Float: A Simplistic Analysis
What Happens
Result
Comparable Inv.
P/L
Bond gets called in 3
months
Make 1% for 3
months
Discount Note at
0.18%
Outperform
alternative
Bond gets called in
1year
Make 1% for 1 year
One year bullets
yield 0.58%
Outperform
alternative
Make 1% for 1yr,
then L+50 until call
or maturity
5yr floater issued by
GSEs would likely
yield about L+10
Outperform
alternative
Make 1% for 1yr then
L+50, capped at 5%
5yr floater issued by
GSEs would likely
yield about L+10
Underperform
alternative
Bond does not get
called
Bond does not get
called and hits the
cap
These outcomes are not conclusive but are broadly representative. There are many possible outcomes
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Key Takeaways
 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
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