Fannie Mae reported Tuesday that the duration gap of its mortgage portfolio narrowed to negative-10 months in September, a development that sparked a relief rally in shares of the government-sponsored enterprise.
A duration gap measures the difference between the average maturity of a company's assets as compared with the maturity of its liabilities. When it is negative, it means that a company's assets are paying off before its liabilities. A large gap generally indicates that earnings will be extremely sensitive to interest rate swings.
Fannie shares tumbled in the past two weeks after it announced that its duration gap had widened to a record negative-14 months in August.
In a press statement, which Fannie issued two weeks ahead of its normal disclosure schedule, chief financial officer Timothy Howard said that his company chose to release the September duration-gap figure early "due to the greatly heightened interest in this number currently."
In an interview, Fannie's chief portfolio strategist, Peter Niculescu, would not say just what actions the company took concerning the duration gap. But he said the narrowing in September was "in line with our long-term strategy and with historical experience."
"When we released the August number, we said that we had wanted to take action to reduce the gap quickly without being specific as to what 'quickly' means, and that is what we have done," Mr. Niculescu said. "I think the conclusion that might be worth drawing is that we do actually have a wider variety of tools than people might have thought, and an ability to operate more quietly than people might have thought."
Fannie's stock rose more than 8%, to trade at $64.50 late Tuesday, after hitting a 52-week low of $58.85 Monday. Analysts were not surprised by the duration-gap narrowing, and many were optimistic - and had remained so throughout the last few weeks - about Fannie's outlook and its ability to continue to close the gap without incurring too severe a cost.
Some had worried, for example, that Fannie would have to buy large quantities of U.S. Treasuries at a time when government bonds were looking pricey and indeed had been rallying as some market players appeared to be betting that Fannie's demand would drive prices even higher.
Robert P. Napoli, a senior analyst at U.S. Bancorp Piper Jaffray in Minneapolis, wrote that the fact Fannie accomplished the narrowing during a month in which the 10-year Treasury dropped 54 basis points to 3.6% "makes it appear likely" that it should "comfortably" get its duration gap back under six months within the next two months, "and possibly sooner, without doing any unusual or disruptive tactics."
Bruce Harting, an analyst at Lehman Brothers Inc. in New York, concurred. "History has shown that the duration gap usually corrects itself, as the liquidating book of short duration mortgages runs off and gets replaced by much longer duration lower-yielding mortgages," he wrote.
Moreover, Fannie has enough callable debt to offset the currently estimated amount of loan refinancings, Mr. Harting added.
But if the rally in the 10-year Treasury continues, he said, Lehman "might need to eventually trim next year's estimate to reflect a larger decline in mortgage yields than would be the case in the cost of funds."
