By Wes Goodman and Jody Shenn
Feb. 20 (Bloomberg) -- Asian investors won’t buy debt and mortgage-backed securities from Fannie Mae and Freddie Mac until they carry explicit U.S. guarantees, similar to those given on bonds issued by Bank of America Corp. or Citigroup Inc.
The risks are too great without a pledge that the U.S. will repay the debt no matter what, according to Hideo Shimomura, chief fund investor in Tokyo for Mitsubishi UFJ Asset Management Co., and other bondholders and analysts in Japan, China and South Korea interviewed by Bloomberg. Overseas resistance may hamper U.S. efforts to hold down home-loan rates and rebuild the nation’s largest mortgage-finance companies.
Even after President Barack Obama vowed on Feb. 18 to sink as much as $400 billion of capital into Fannie Mae and Freddie Mac, double the original commitment, “there is still a concern that there is no guarantee” from the government, said Shimomura, who oversees $4 billion in non-yen bonds for the arm of Japan’s largest bank.
“Looking at the risk, they’re not so attractive,” he said. “We need a guarantee before we’ll buy.”
Foreign investors sold $170 billion of agency debt and securities in the second half of 2008, the largest amount since the Treasury began tracking sales in 1977, according to the most recent data. Asians, the biggest non-U.S. block of owners in the category, unloaded $70 billion worth from July through December, after scooping up $55 billion in the second quarter and being net buyers during much of the last decade.
The sell-off and calls for a guarantee reflect a continuing lack of confidence among foreign investors five months after the U.S. seized control of Fannie Mae and Freddie Mac. The takeovers followed the biggest surge in mortgage defaults in three decades.
Buying Programs
Without restoring foreign demand, Federal Reserve Chairman Ben S. Bernanke will find it more difficult to cut rates on housing loans, which depend on the ability of the finance companies to attract investors for their securities at the lowest possible yield. Fannie and Freddie sell debt to fund their purchases of mortgages.
At a minimum, the Fed may have to spend more than $600 billion in its buying program for securities issued by Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Banks, according to Margaret Kerins, an agency-debt strategist at RBS Greenwich Capital in Greenwich, Connecticut. The Treasury also bought $94.2 billion worth of mortgage-backed securities to make up for the withdrawal of foreign investors.
“You’d be back to the situation that prompted them to act” if the purchases of Fannie and Freddie debt were discontinued before foreign investors return, she said.
Yield Spreads
The Fed’s buying program resulted in a yield of 2.06 percent on Fannie Mae notes maturing May 2012 at the close of trading Feb. 18 -- 0.15 percentage point less than government- guaranteed Bank of America bonds maturing a month later and 0.12 percentage point less than similar Goldman Sachs Group Inc. debt, according to RBS Greenwich data.
Yield gaps between Fannie Mae’s 10-year debt and Treasuries have narrowed from the record of 1.75 percentage point set in November, after countries worldwide announced plans to back bank bonds and offer buyers more federal guarantees. At 0.67 percentage point, it is now 0.30 percentage point above what the spread averaged in 2006, according to data compiled by Bloomberg.
The average 30-year fixed mortgage rate fell to a record low of 4.96 percent last month from 6.47 percent in the last week of October, according to Freddie Mac surveys. It rose to 5.04 percent during the week ended yesterday.
Half of $12 Trillion
Fannie Mae, based in Washington, and Freddie Mac, in McLean, Virginia, have about $1.7 trillion of corporate debt outstanding and $3.7 trillion of their guaranteed mortgage-backed securities held by other investors. The two mortgage companies finance almost half of the $12 trillion of residential loans outstanding.
The government-run conservatorship won’t end until the mortgage market recovers and the companies regain profitability, Federal Housing Finance Agency Director James Lockhart said yesterday on Bloomberg Television. He took charge of Fannie and Freddie last September and describes the companies’ U.S. backing as “effective,” though not “explicit.”
That’s not enough for foreign investors these days, said Laurie Goodman, a senior managing director at Austin, Texas- based Amherst Securities Group LP. Goodman was a former head of fixed-income research at UBS AG.
‘Full Faith’
“Overseas investors are looking for the full-faith-and- credit clarification,” Goodman said. Such a pledge would essentially about double the U.S.’s debt, potentially boosting the country’s own borrowing costs.
“The U.S. government is worried about the agency market, and market participants feel the same way,” said Kei Katayama, head of the foreign fixed-income group in Tokyo at Daiwa SB Investments Ltd., who oversees $1.6 billion of non-yen bonds for the arm of Japan’s second-biggest brokerage.
Katayama sold all of his agency debt on Sept. 16, the day after Lehman Brothers Holdings Inc. filed the biggest bankruptcy ever, taking it as a sign to get out of riskier assets, he said.
The bonds also have been difficult to sell after credit markets froze last year, according to Jaemin Cheong, who trades U.S. securities in Seoul at Industrial Bank of Korea, South Korea’s biggest lender to small and mid-size companies. He said he won’t touch them.
Hedge-Fund Sales
Sellers in the fourth quarter included Caribbean-based investors, often hedge funds, which dumped a net $35.8 billion of the agency debt and securities after buying $15.7 billion in September. China sold $10.4 billion in the period after unloading $8 billion in September, while South Korea got rid of $10.5 billion.
“China’s demand for U.S. agency bonds will gradually decrease because China has drawn lessons from the credit crisis and learned to invest smarter,” said Yi Xianrong, a researcher at the Beijing-based financial research institute of the Chinese Academy of Social Sciences, which advises the government. “We will try to stay away from these types of bonds.”
Freddie Mac Treasurer Peter Federico connects the sales to certain institutions and doesn’t think it is part of “a broader liquidation,” although “it kind of felt like that for a couple of weeks or months later in the year.
“There are a couple of institutions who continue to sell agency debt,” he said in a Feb. 18 telephone interview. “I think their reasoning for doing that is not related to their comfort with our credit. It’s their own monetary-management and currency-related issues. Apart from those institutions, I don’t believe there is a lot of demand to sell going forward.”
Freddie Mac Treasurer
Federico spoke after the company completed a record $10 billion, three-year note sale at yields of 2.24 percent, or 0.02 percent more than JPMorgan Chase & Co. offered in a sale of government-guaranteed, three-year debt of the same size.
Asian investors bought 12 percent of this week’s sale, and North American investors purchased 72 percent, according to the company. The U.S. share was high in comparison to recent years, “but it’s very consistent with what we’ve seen over the last six months, where the U.S. domestic investor who probably understands the conservatorship status better than foreign investors has really been supporting the market in a big way,” said Drew Ertman, head of financial-institutions debt coverage at Morgan Stanley, one of the underwriters.
Amy Bonitatibus, a Fannie Mae spokeswoman, declined to comment.
Attractive Alternatives
Sales of agency debt and securities may be more closely tied to the availability of better returns in corporate bonds than a lack of faith among investors, according to Andrew Harding, chief investment officer for fixed income at Allegiant Asset Management in Cleveland. Those include bank debt with explicit U.S. guarantees offering higher yields, he said.
“I don’t think the credit quality or housing market has precluded people from buying agency debt right now,” said Harding, who helps manage $20 billion for Allegiant. “There are just more attractive alternatives.”
Fukoku Mutual Life Insurance Co. spent last year trimming “risky assets,” and it sold all agency holdings in the third quarter, said Satoshi Okumoto, general manager at the company in Tokyo, which has $63.5 billion in assets.
“It’s not really the same credit” as government debt, Okumoto said. “It’s one step below.”
To contact the reporters on this story: Wes Goodman in Singapore at wgoodman@bloomberg.netJody Shenn in New York at jshenn@bloomberg.net.
Last Updated: February 20, 2009 03:33 EST 
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