FDIC May Let Banks Hold More Fannie Mae and Freddie Mac Debt

2008 October 8

October 7 2008 - Regulators plan to reduce capital requirements for banks holding Fannie Mae and Freddie Mac debt and mortgage bonds, potentially freeing up more money for loans.

The Federal Deposit Insurance Corp. today tentatively approved a rule, proposed by all four federal bank regulators, that eases capital requirements for federally insured depository institutions that hold large amounts of Fannie and Freddie corporate debt, subordinated debt, mortgage guarantees and derivatives. The so-called risk weighting for banks on Fannie and Freddie’s credit claims was cut to 10 percent from 20 percent.

“The assumption would be that the government is standing closer behind the debt of Fannie and Freddie,” said Alan Bosworth, director of government and agency trading at Vining Sparks in Memphis, Tennessee. “You don’t have that many zero percent risk weightings that banks can invest in.”

The rule means banks including Bank of America Corp. and Wells Fargo & Co. may need to raise less capital through share sales or dividend cuts, allowing them to increase their lending and investing. Mortgage analysts at JPMorgan Securities Inc. estimate the change would free up about $15 billion in reserves.

The loosening of capital constraints may not spur the boost in purchases of Fannie and Freddie debt that regulators may have been seeking, said Ira Jersey, a U.S. interest rate strategist at Credit Suisse Holdings USA Inc. in New York.

“Are financials willing to take on more risk just because they have additional capacity?” Jersey asked. “In this environment, they’re unwilling to take on much additional risk. They don’t want to spend capital, they want to preserve capital.”

Not Going to Work

Banks can hold unlimited amounts of Treasury debt, securities issued by government mortgage-bond insurer Ginnie Mae and a handful of other federally backed bonds without affecting their capital requirements. Lowering the regulatory risk weighting on Fannie and Freddie’s securities by half essentially doubles the industry’s capacity to buy more of their paper.

Paul Miller, a bank analyst at Friedman Billings Ramsey & Co. in Arlington, Virginia, also doubted whether the change will spur demand or lower mortgage rates.

“I know what they’re trying to do, but it’s not going to work,” Miller said. “Just go down the list of all these programs that the market rallied on only to lose their steam later because they didn’t solve the underlying problem. People aren’t paying their mortgages and the banks are overleveraged.”

Jersey said the change should incrementally improve Fannie and Freddie’s funding costs, “just perhaps not what would be hoped.”

Bank Holdings

The difference between yields on Fannie’s current-coupon 30- year fixed-rate mortgage securities and 10-year Treasuries today narrowed 6 basis points to 175 basis points as of 12:15 p.m. in New York, data compiled by Bloomberg show. The spread compares with a low of 153 basis points since the Sept. 7 government takeover of the companies, and the 22-year high of 238 basis points set in March.

U.S. commercial banks and thrifts held $875 billion of Fannie, Freddie and Ginnie Mae mortgage securities as of June 30, according to Inside MBS & ABS, an industry newsletter. Bank of America was the largest holder of Fannie and Freddie mortgage bonds, with $173.2 billion, followed by JPMorgan Chase & Co. with $75.8 billion, Wachovia Corp. with $60.9 billion and Wells Fargo with $44.5 billion, according to the newsletter.

The top 25 investors among the 50 largest commercial-bank holding companies owned more than $490 billion of Fannie and Freddie mortgage bonds.

Special Treatment

The Federal Housing Finance Agency took control of Fannie and Freddie after $14.9 billion in combined quarterly losses in the past year. As part of the takeover, the Treasury took steps to improve the mortgage market, throwing the backing of the U.S. behind Fannie and Freddie debt and saying the companies will increase holdings of mortgage securities. The Treasury will also buy the bonds.

The FDIC proposal, which will be open for a 30-day public comment period, doesn’t apply to common or preferred stock. It also doesn’t apply to debt issued by the Federal Home Loan Bank system, which may place the lending cooperatives at a competitive disadvantage. Comptroller of the Currency John Dugan proposed at the FDIC’s meeting in Washington today to add the FHLB debt, which carries a 20 percent risk weighting, to the final rule.

If the 12 regional home loan banks are left out of the final rule, it may increase their debt costs, which have risen to about 30 basis points higher than Fannie and Freddie’s in recent weeks. Historically, debt issued by Fannie, Freddie, the home loan banks and Farm Credit System has cost roughly the same when compared to U.S. Treasuries. A basis point is 0.01 percentage point.

FHLB debt securities were already “trading so far behind Fannie and Freddie,” said Rajiv Setia, a mortgage strategist at Barclays Capital in New York. “Not having them analogous for the home loans would solidify the perception that Fannie and Freddie are special and the others aren’t.”

FDIC May Let Banks Hold More Fannie, Freddie Debt
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