|The more that we consolidate our trading activity as well as our issuance, I believe firms will allocate more capital to Freddie Mac. If we just transact with people occasionally, I dont think those firms will be so committed to our name |
Tim Bitsberger, Freddie Mac
He is Freddie Macs third treasurer in the past two years. His appointment is a change from the norm at Freddie of an internal candidate emerging. His recent background means he is well placed to guide the mortgage financer in its new regulatory and accounting environment.
Bitsberger says there are distinct similarities in funding ethos between working for a GSE (government-sponsored enterprise) and working directly for the US Treasury. What Freddie and the US Treasury are in sync with is that we both believe that if we can outline our plans to the fullest degree that we can, and are transparent and predictable in our issuance, that will allow us to receive a liquidity premium in the marketplace.
Freddie argues that its communication strategy distinguishes it from competitors. At the beginning of each year it issues a funding calendar for the year ahead that sets out the planned announcement, pricing and settlement dates of all its reference securities, their maturities and even the likely size of the issue, where known. Then, in its quarterly funding announcement, it firms up exactly what it is going to do in the next three months.
That, says Bitsberger, who is responsible for debt and mortgage funding programmes as well as debt, equity and mortgage investor relations, leads to satisfied investors. We tend to get feedback when people are unhappy about something that weve made a change or reduced issuance and they dont like it, he says. The fact that weve had little feedback recently is a sign that were doing a good job.
Transparency in all areas of Freddies business has been of utmost importance since the agency was forced to restate all its earnings from 2000 to 2003. In that respect, it has been playing catch-up ever since. Although it plans to return to quarterly reporting by the end of the year, in March the agency announced that it was delaying issuing its 2005 financials for two months until May. We have made substantial progress in fixing our financial reporting infrastructure, but our work is not done, says Martin Baumann, Freddie Macs chief financial officer, who announced he was leaving at the end of March after seeing the company through this difficult period. Getting this infrastructure to the point where it can support timely, reliable quarterly reporting continues to be an enormously complex task.
However, John Radwanski, vice-president and assistant treasurer, says Freddie Mac didnt change its asset buying or risk management plans as a result of the restatements and the only changes to funding have been at the margin. It still has a triple-A long-term unsecured rating at all three major rating agencies. The only change was that we saw more volatility in spreads in certain markets, so weve had to be more cognizant of where we fund at times.
As Euromoney was going to press, the company was on the verge of issuing its quarterly funding guidance for the second quarter. Radwanski says the next couple of quarters will be very similar to the last two pending any significant changes in its mortgage portfolio growth. Weve seen slightly higher amounts of our reference note issuance as well as our callable issuance over the last couple of quarters and that is likely to continue.
By the end of March, Freddie had issued $20 billion of its US reference notes in the first quarter, which had already increased its outstandings by more than $5 billion in this market as it only had $14.3 billion of reference notes maturing by the end of March.
Looking at global callable debt
Greater activity in the global callable debt market, in particular, is going to be a top priority. Although Freddie has issued $25.7 billion of MTN callables so far this year, it has not issued any syndicated callable notes since its $1 billion five-year non-call one in February 2005, compared with more than $15 billion of syndicated callables in 2004. Issuance of callable notes, which are much shorter in duration than non-callable paper, is one thing that has lowered the convexity in the mortgage portfolio, which means Freddie Mac is less reliant on derivatives hedging. As a result, derivatives hedging has dropped to about $500 billion. It used to be at least twice that. In fact, now there is $250 billion of callable debt outstanding, which funds more than 50% of the fixed-rate mortgage portfolio.
The sensitivity of the portfolio to interest rate risk has remained consistently low. For more than a year, the sensitivity of its portfolio market value to a 50 basis point shift in the yield curve has stayed at 1%, something the treasury team is rightly proud of.
Another of Bitsbergers goals is to ensure that Freddies bookrunners continue to allocate capital to the firm and trade with it in the debt, mortgage and derivatives markets.
Like other issuers, we have a dealer scorecard that we routinely consult to make sure that were allocating business correctly, he says. But I do think we need to be careful not to spread issuance too thin. The more we consolidate trading activity as well as issuance, I believe that those firms will allocate us more capital. If we just transact with people occasionally, I dont think those firms will be so committed to our name.
Back to buying
Freddie hopes that it will be able to build up its retained portfolio once again this year and buy more mortgages on an opportunistic basis. The retained portfolio was massively scaled back in 2003 and 2004, reducing overall new debt issuance requirements by about $600 billion between 2002 and 2003. However, in 2005 it grew its retained portfolio by 9% as it bought more non-agency mortgage bonds, as well as some fixed-rate mortgages, so total debt issuance is beginning to creep back up again.
However, it was not a buyer of fixed-rate mortgages, which form the bulk of its portfolio, until the end of last year, when the option-adjusted spread widened. Freddie attributes this to the flattening yield curve, which reduced the arbitrage opportunities for bank purchasers in the market, dampening demand. Overall, its retained portfolio grew in November and December on an annualized basis at 25.8% and 29.9% respectively.
However, the retained portfolio was scaled back by 9.9% in January because of spread compression in the market. We are opportunistic and we have a mandate to support the secondary market for mortgages. Right now, though, that market is very well bid, says Bitsberger. A lot of players that are new to the market have increased their activity, so we continue to be patient. Freddie is waiting for option-adjusted spreads to widen again before it considers buying more mortgages. It is confident this will happen in 2006.
The agency is still committed to buying non-agency mortgages in 2006. However, given that agency mortgages are trading very tightly by historical standards, largely because new, foreign investors have moved into this market in scale, are there likely to be significant arbitrage opportunities for the GSEs on the horizon? Bitsberger thinks so.
Federal Reserve data show that foreigners are more active in the mortgage-backed space, he says. A lot of central banks are diversifying and mortgages are a logical place to go. But I think a lot of it is relatively new. I think its interesting to note that a lot of these investors have never experienced a pre-payment wave, so Id be curious to see how theyll react if and when that occurs. I think youll see that when the opportunity arises, we will be very active in the market.
One major issue hanging over all the GSEs is greater regulation following the accounts restatements. A bill that passed the House of Representatives last October, if signed into law, would create a stronger new regulator. This would be empowered to put the GSEs into receivership in the event of a default and impose tougher capital standards. Freddie says it is happy with what came out of the legislature, as a stronger regulator would enable it to maintain its GSE status and the confidence of the capital markets.
However, its still unclear exactly what a new law, if it is ratified, will look like or indeed its impact on Freddies ability to grow its portfolio or its funding. The agency is quick to point out, though, that it retains a hefty amount of capital at the moment $4.7 billion above the agreed 30% capital surplus it has been required to maintain in 2004. It therefore feels it is in a strong position.In the short term, though, the company is concentrating on keeping tight control over risk management and being nimble enough to quickly ramp up matched funding as soon as the door opens for it to grow its mortgage portfolio once again.
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