With the issuance of its upcoming second Euro Reference Note, for EURO5 billion - officially launching and pricing this week - Freddie Mac is hoping to establish in the Euro market what it has dubbed "The New Liquidity," offering investors sovereign-like liquidity with credit-product returns.

"Of 119 issues that currently trade on the Euro MTS trading platform, Freddie Mac's last Euro issue ranks as the third most actively traded bond, and it ranks second, if you consider that the first two top-rated are both from the same country, Italy," said Jon Prince, the managing director of debt marketing at the GSE. "And how are we doing that? MTS is an inter-dealer platform, and dealers know our name very well. They've seen our U.S. dollar product, and our last bond was a clean 10-year issue."

And now, fulfilling its commitment to issue EURO20 billion in Euro Reference Notes per year, Freddie is following up its first EURO5 billion 10-year bond with a EURO5 billion five-year bond, as it works toward a full yield curve of issuance in the Euro market.

The overriding objective of the program is to diversify the GSE's funding sources while preparing for the future. "If you look at our growth and extrapolate forward another decade, and anticipate the likely financing requirement of the U.S. housing system - which is estimated to be $6 trillion over the next ten years - our view is that we should prepare ourselves for borrowing in other currencies," Prince said.

And the GSE did not penetrate the European market easily: prior to the first Euro Reference Note, European by-laws precluded anything but sovereign debt from trading on the MTS platform. Freddie Mac had to petition a by-law amendment and was successful, even though the MTS platform did not slacken its requirements. Issues must have a face amount of EURO5 billion or more, and hence the minimum offering size of Freddie's bond was EURO5 billion."

Even more reassuring to Freddie Mac is that of 270 investors for the first Reference Note, over half had never purchased agency securities before. "So this means we are tapping new sources of capital, which is good," Prince noted.

Additionally, Prince expected that at least a few investors who bought the Euro notes would be tempted to buy their U.S. dollar equivalent somewhere down the line. "While we're not expecting a reverse spillover, and we are tapping into an investor base that favors the Euro, investors might become aligned with the Freddie name, so crossover business may not be an unlikely thing," Prince pointed out.

Shaky Pricing?

Rumors circled the market last week that early price talk on this week's Freddie Euro issuance might not be as good as the GSE would like.

Prince admitted that the first Freddie Mac issue "priced a little bit less expensively" than the agency would have liked, and hence more costly to the GSE than its U.S. dollar product. But Prince believes that the issues will gradually tighten as the instrument becomes more widely known.

"Our book is building steadily and nicely to the best of our knowledge," Prince noted.

Sovereign spreads for Euros have been doing fairly well recently, but some analysts expected the GSE to offer a three to four basis point premium to debt from zero-risk European entities such as the European Investment Bank or Kreditanstalt fur Wiederaufbau.

"We would disagree that it's not fairly priced," Prince said. "The latest price talk is in the range of Euribor minus 9 to 11, so by no means is it an eye-popping or unreasonable stretch [from our last issue]. Global arbitrage economics will generally work to bring the two pricings together, since they are both large liquid issues, and the same credit. We expect it will converge on an equilibrium price."

Filling a Liquidity Void

According to Prince, Freddie Mac chose to enter the Euro market because of some of its similarities to the economics of the U.S. dollar market from a few years ago.

"A lot of people ask us why we chose the Euro market, and not, say, the Yen market. The Euro market has a lot of parallels between itself and the U.S. dollar market of 1998," Prince said. "Government supply has shrunk. In the U.S., there are the Treasury buybacks. Similarly, Euro-dominated paper is declining, which created a liquidity void in Europe, and there is no other product there now that offers this type of liquidity."

Interestingly, 6% of the buyers of the first Euro Reference Note were U.S. investors who found it cheaper to buy Freddie debt in Euros and swap it back to dollars, and the distribution of the first issue was widespread over 20 countries. Additionally, 13% of the issues went to international central banks.

"Central banks love U.S. agencies," Prince said. "As this product catches on, we expect to diversify our funding levels even further."

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