IFR Top 250 2007: Freddie weathers the turbulence
Given the turbulence in the US housing market and increased pressure and oversight from regulators and the Congress, running a large government-sponsored enterprise remains challenging. But as the US housing market remains a staple of the US economy, Freddie Mac continues to raise money in myriad ways to ensure a stable source of funds for homeowners. John D’Antona reports.
Freddie Mac's mission is to provide a stable supply of money for US consumers to purchase their homes. As a provider of such funding, the company strives to provide financing not just for top-shelf consumers, but also for low- and moderate-income customers. It does this buy tapping the US financial markets regularly via several programmes, including the maintenance of a retained portfolio and issuance of US mortgage backed securities, Reference Notes and other instruments.
As a federally chartered enterprise, Freddie Mac often garners preferential treatment in the capital markets as it carries an implicit government guarantee. Its senior long-term debt is rated Triple A by all three ratings agencies and its subordinate debt is ranked Aa2/AA–/AA–, while its US RMBS securities are rated Triple A by the agencies and credit markets.
One of the staples of Freddie Mac's borrowing vehicles are its Reference Notes, issued regularly in the US credit markets in two, three, five and 10-year maturities along a publicly released and defined schedule. The agency's most recent offering was a US$4bn 5.0% security, auctioned on May 23, and was priced at 99.851 to yield 5.076%, or 23.5bp more than two-year US Treasury Notes.
Including that deal, Freddie Mac has issued US$25bn of Reference Notes securities during 2007 (up to the end of May) and has approximately US$238bn in Reference Notes and Reference Bonds securities outstanding.
Freddie Mac issues a variety of fixed and floating-rate, medium-term notes (MTN) of different maturities, lockouts, and call provisions. Most MTNs have embedded call options. Freddie Mac uses callable debt to manage duration, convexity, and volatility risk of its mortgage portfolio.
MTN Callables are generally issued through a reverse-inquiry process whereby investors and underwriters can customise the structure to match their needs for yield, structure, and size. Syndicated Callables are large and liquid callable notes that are issued through a syndicated book building process according to a pre-announced schedule with a minimum size of US$1bn and include a European (one time) call option. These securities are designed to meet the liquidity needs of large institutional investors.
The company will also periodically issue subordinated debt (Freddie SUBS) to further augment its borrowing needs, which it has done with the oversight of the US Office of Housing Enterprise and Oversight. Freddie Mac will issue subordinated debt for public secondary market trading and rated by no less than two nationally recognised statistical rating organizations.
Freddie Mac also manages its retained portfolio to help meet its funding needs, often by buying mortgages. Freddie Mac is the second-largest US purchaser of home mortgages, which it packages into securities for sale to investors to raise funds for additional mortgage funding.
Over the last four months, the agency total mortgage portfolio has purchased US$191.9bn in MBS, an annualised growth rate of 17.9%. Its retained portfolio has purchased US$72bn as of April, an annualised growth rate of 2.2%.
To insulate itself from troubles in the US housing market, in particular the sub-prime market, the agency announced that from September 1 it would no longer purchase home equity ABS loans and classes backed by borrowers not qualified at the first reset level mortgage payment, as opposed to buying them at teaser payment levels, which it had done previously.
"As we've discussed in the past, at the end of 2006, Freddie had basically no sub-prime exposure in our guarantee business, and about US$124bn of AAA rated sub-prime exposure in our retained portfolio," said CEO Dick Syron.
"My overarching thesis is that, notwithstanding current market conditions, Freddie is in a strong position not only to weather a housing downturn, but also to keep serving our mission and building shareholder value. Freddie has managed to increase the growth rate of our guarantee business. This has been a strategic priority for us, and we have made significant strides in improving our customer relationships and broadening our mix of business across customers and mortgage products."
Syron added that the agency had achieved this growth by maintaining a disciplined approach in underwriting the credit risk it takes on, and by enhancing the value proposition it brings to customers.
"The firm economically hedges far more of the interest rate risk of our portfolio through the use of callable debt than most financial institutions, including our large bank competitors," he said.