The Federal National Mortgage Corp.'s recent announcement that it intends to buy as much as $1.0 billion of housing bonds by yearend has significant repercussions for investors, issuers, and Wall Street underwriters.
When the government-sponsored enterprise, better known as Fannie Mae, won the competitive bid on the Minnesota Housing Finance Agency's $47.5 million sale of revenue bonds last week, it raised a number of issues: most notably, how can private firms compete with a government-sponsored enterprise, and what impact will a major push from Fannie Mae have on pricing in the housing sector?
The Minnesota deal marked Fannie Mae's first successful competitive bid, and the agency beat out several large Wall Street concerns in the process.
Following the award of last week's Minnesota issue, Jack Gallagher, vice president of public finance at Fannie Mae, said the agency plans to buy a total of between $750 million and $1.0 billion of new-issue, single-family, and multifamily housing bonds for its investment portfolio by the end of the year.
State housing finance agencies may welcome increased demand from such a major buyer, but investors may feel the pinch of lower yields. And since Fannie Mae intends to buy bonds directly at competitive auctions, in addition to negotiated private placements, underwriters will have the challenge of dealing.with a major competitor in a year when profits are already being squeezed by lower volume.
"I don't think the investment banking rinns can compete with a federally subsidized agency," said one Wall Street executive, speaking anonymously. "Fannie Mae has a lower cost of capital. Whatever they want to do, they're going to do it better [than the private industry]. Fannie Mac is very strong and powerful, and people on the Street are afraid of them."
Officially, however, in what some describe as an ostrich-like approach, most investment bankers say the competitive threat from Fannie Mae is limited.
"They've done things like this before, but on a private placement basis," said one research analyst at a major investment banking firm. "Yes, they are a force to be reckoned with, and you'll see more and more of it, but it's something I've seen them do for years."
Some market sources say Wall Street firms may be downplaying their concern about competing with Fannie Mac for fear of raising the ire of a major client that also has high-powered friends in Washington.
"They're one of the single biggest clients for every firm on the Street, so I don't see how anyone who does business with them could really comment because [Fannie Mae] is so powerful," another analyst said. 'There's a lot of sensitivity on this issue."
Many Wall Street officials and members of the industry's trade groups declined to comment for this article.
In contrast to investment bankers, institutional buyers and housing analysts are openly concerned that Fannie Mae will swallow up a large chunk of the new-issue housing bond market.
"There's a lack of supply in the first place, [and] if they're going to take a billion dollars out of the market, I think it would be felt," said Bradford N. Langs, housing bond analyst at Kemper Securities Inc. "For someone who wants to buy new issues, it's going to hurt because [they'll] get a lower yield" as dwindling supply translates into higher demand and higher prices.
For municipal market participants, the issue's significance is compounded by the growth of housing bond volume this year in contrast to the decline in overall issuance.
Through the first six months of the year, housing bonds -- issued mostly through negotiated transactions -- totaled $7.1 billion, up 13% from the previous year, according to a recent report from Kemper. By comparison, overall tax-exempt volume was down 38.9% from the first half of last year, the report said.
"It's pretty clear they're going to put money into this area, and that's something for future concern," said Thomas C. Spalding, manager of the $2.7 billion Nuveen Municipal Bond Fund. "I've got to believe that if Fannie Mae continues [to buy housing bonds], spreads will continue to be lower on the housing side."
Fund managers can "generally pick up 15 to 20 basis points because of call risk" with housing bonds, Spalding said, noting that just under 20% of his fund is concentrated in the sector. But continued buying from Fannie Mac could pressure spreads so much "you could see that get down to 10 basis points," he said.
Andrew Jennings, vice president of municipal trading and senior portfolio manager at Franklin Advisers Inc., agreed that competition from a major buyer like Fannie Mae could pressure spreads in the housing bond sector, but said "it's too early to tell."
Jennings is the manager of the $7.0 billion Franklin Tax-Exempt Fund, about 15% of which is housing bonds.
"If we're not going to get paid for that call [risk], then the hell with it," he said. "If we lose that as a sector, then we'll go on to something else. There's always going to be bonds."
Kenneth E. Willman, manager of the $2.0 billion USAA Tax-Exempt LongTerm fund took a similar outlook.
"Having that much supply go out would make housing bonds more expensive, for sure, but there's nothing I can do about it," Willman said. "It will make it harder to buy new housing bonds, but it will make the ones already in our portfolio more valuable, so there's pluses and minuses."
About 18% of the USAA fund consists of housing bonds.
Officials from the National Council of State Housing Finance Agencies did not return repeated inquiries on the subject.
Regardless of the contrasting views among municipal market participants, Fannie Mae plans to make competitive bidding for state housing agency deals a part of its normal practice of business.
Fannie Mae has purchased about $4.0 billion in tax-exempt housing bonds for its investment portfolio since 1987 through negotiated private placements, Gallagher said. With a $243 billion investment portfolio at June 30, the quasi-government enterprise certainly has the resources to engulf major portions of the housing bond market.
"Our reason for buying bonds is to assist housing finance agencies in providing affordable housing," Gallagher said. "We've done that very successfully in private negotiated transactions, and we felt that by expanding our activities by submitting competitive bids we could bring the same cost savings we've brought in negotiated transactions."
Fannie Mae was able to offer the Minnesota housing agency a lower bid, in part because the agency bought the bonds for its own portfolio, unlike investment banking firms that buy the bonds and then seek to resell them to institutional and retail buyers.
"Fannie Mae did not seek any reimbursement for takedown expenses Ion the Minnesota deal] because we're not investment bankers," Gallagher said. "That translated into a net savings for the Minnesota HFA [which] can be passed on to first-time home buyers in the form of lower mortgage rates."
Fannie Mae's intensified focus on the tax-exempt market is part of its "Showing America A New Way Home" initiative, unveiled last March.
The initiative commits Fannie Mae to invest $1.0 trillion by the year 2000 to finance more than 10 million homes for low-income families and communities.
Fannie Mae's apparent eagerness to increase its participation in the tax-exempt market has housing market participants worried about the possibility of competing with another government-sponsored enterprise, the Federal Home Loan Mortgage Corp., known as Freddie Mac.
Freddie Mac, which is structured similarly to Fannie Mae, purchases residential mortgages from lenders and then resells them in the secondary market.
Freddie Mac officials declined to comment on the corporation's designs in the tax-exempt market.
