Fannie and Freddie: Will foreign agencies fill the gap?

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The fee hiatus left by Fannie and Freddie will be filled. But not just yet.

With Fannie Mae and Freddie Mac being wound down, the big question is where are Wall Street’s fees going to come from now? According to Thomson Reuters, from the beginning of 2009 to the end of March 2011, Fannie Mae produced $1.57 billion in fees for the investment banks and Freddie Mac $1.26 billion – the largest contributors of fees globally, with JPMorgan, Bank of America Merrill Lynch and Goldman Sachs the biggest beneficiaries. Total global market fees were $188 billion for the period, making those two agencies accountable for 1.5% of all fees.

Market participants seem unperturbed. Much of their reasoning is that investors have to buy something, so ‘something’ will replace them. That something apparently lies in foreign triple-A-rated agencies – good news for those entities that have struggled to attract a US investor base.

Already this year US dollar covered bond issuance from foreign banks has shown signs of taking off. US investors are beginning to thaw to foreign names as they start to contemplate where triple-A-rated paper supply might come from, and foreign issuers are grateful for the diversification of their investor base.

The growth of a foreign covered bond market in US dollars and seemingly positive developments in legislative discussions point to a US covered bond market being formalized that could also help fill the gap, if not for some time.

It’s too early to discern when a US covered bond market might materialize – talks have been continuing for more than five years and the Federal Deposit Insurance Corp always seems to act as a barrier. Signs of replacements might first be noted in the US MTN market.

Fannie and Freddie’s fee production is dominated by their medium-term note issuance rather than benchmark deals. In 2010, Fannie and Freddie accounted for 54% of all US MTN issuance. With the Federal Home Loan Banks System as the third-biggest issuer, those three accounted for more than 70% of the entire US MTN market.

Now, say MTN desk officials, US investors of structured MTNs are starting to ask what foreign supras and sovereigns might replace the two agencies as they wind down. European, Canadian and Asian issuers are reportedly taking note and looking to establish programmes to meet demand.

Are we going to see a smooth shift from Fannie and Freddie to foreign issuers? It’s unlikely. There will probably be gaps as US investors seek to educate themselves on foreign sovereign agencies. Fees look choppy from here on in, but Fannie and Freddie’s departure doesn’t look quite as bad for Wall Street as it first seemed. For foreign agencies it’s positively a relief.