With total Freddie Mac production for the month of January down significantly, market observers are wondering if the GSE is actually losing market share to rival Fannie Mae, or if it's merely a case of monthly fluctuations in production flows.
In January, total Gold production dropped to $40.3 billion (comprising 30.6% of conventional production), which is a 34% month over month dip. The last time Gold production dipped this low relative to total conventional issuance was back in April 2000, when it only comprised 34% of production during a period when total conventional issuance was $16 billion, according to analysts from Countrywide Securities. They added that the decline in production was somewhat more pronounced in 30-year Golds, which dropped 37%, while 15-year Gold issuance fell 27%.
Countrywide analysts said that the relative decline in issuance was partly due to the current weak pricing of Gold PCs relative to Fannies. For instance, they cited that 30-year Gold/Fannie 5.5 swap continued to trade around negative 1/32, compared to the economic value of the delay-date difference of about 6/32s. They explained that this would really matter to issuers looking to evaluate execution options.
Contributing to this pricing anomaly is the fact that Freddie has not really been actively buying PCs for its portfolio. According to their Monthly Volume Summary, Freddie's retained portfolio is still growing at a rapid rate, which is stated at 41% annualized in December. However, while retained purchases grew by $4 billion last month, PC repurchases - comprised by the buying back of Gold passthroughs previously sold into the secondary market-went down by $2 billion. Countrywide suggested that the recent growth in Freddie's retained portfolio is a result of purchases in non-PC items, including whole loans bought through the cash window.
Three reasons were mentioned by a recent UBS Warburg report that caused the low Gold production: price spreads, timing of expiration of alliance agreements, and enforcement of delivery fees.
Analysts said that because of price spreads it has been more favorable for originators to sell to Fannie than to Freddie. This is why originators who are not tied up in alliance agreements are pursuing this alternative route. Alliance partners could also sell product away, and going forward might take advantage of this.
They mentioned that the alliance agreement between Freddie and Bank of America-which has traditionally been a large Freddie alliance partner - expired at the end of last December. BofA has publicly stated that it will be ending its exclusive relationship with Freddie. With BofA not selling anything to Freddie in January, sales to Fannie were up by a corresponding amount. Analysts said that as the alliance agreements expire originators may opt to renew while others will become "free agents" that will sell to both Agencies, which would, in turn, introduce more variation in month-to-month market shares between the two Agencies, analysts said.
The third reason cited by UBS Warburg was that Freddie has been much more vigilant in their enforcement for delivery fees on A minus collateral, which the GSE started enforcing beginning Jan. 1, 2003. Researchers said that this contributed to the particularly low share of Gold 6.0s production in January.
In a separate report, Merrill Lynch analysts mentioned that there were far fewer Golds produced in January than in December. On the other hand, Fannie Mae production actually rose.
Merill looked at 5.5s and noted the relative shift between December and January was because of a few large issuers. As widely known, most of the issuers are aligned with either one of the GSEs. Countrywide and Washington Mutual are large issuers associated with Fannie Mae and Wells Fargo and ABN Amro are identified with Freddie.
Between December and January, while Countrywide and WAMU both boosted their issuance by approximately $6.5 billion, Wells and ABN decreased their issuance by roughly $3.7 billion, resulting a net swing of roughly $10 billion. Aside from this, BofA's ending of its exclusive ties with Freddie coincided with a corresponding shift in production to Fannies in the order of $3 billion. Combined, these major issuers comprised a net swing of $13.4 billion from Golds to Fannie 5.5s, which made up most of the total swing of $15.8 billion.
Analysts said that the explanation for the shift is not entirely clear, but they point to two factors as possible reasons. One is the better execution for issuers on the Fannie side and another is the fact that Fannie's commitments fell from $53 billion in November to about $29 billion in December, which most likely freed up more 5.5s to come to market in securitized form.
Merrill analysts said that the increase in Gold/FNMA swaps would probably begin to shift at least some issuance back toward Golds, from those issuers who are not under contract with any of the GSEs. But a large part of the issuance changes in January was due to Wells, ABN, Countrywide and WAMU, which are associated with specific agencies, so it is not really clear that the rising swap will shift issuance back the other way, analysts said.
"We therefore do not expect the Gold/FNMA swaps to give up much ground until the empirical evidence begins to suggest increased issuance of Golds," wrote Merrill analysts.
Talk in the market
Market observers said that Fannie's recent advantage over Freddie would not continue indefinitely because of the underlying competition between the two agencies. Freddie Mac will most likely quickly move to neutralize Fannie's perceived strategic advantage.
Further, Golds were starting to show some strength. By Wednesday last week, Gold 5.5s had richened a couple of ticks against Fannies, making them more attractive for originators who could issue both. This made pricing better for Golds than it was a week prior.
"The market tends to correct itself, " said a mortgage strategist. "I don't think the market wishes to have a single monopoly so if Fannie Mae gets too high a share of the issuance, the market would correct for it because Golds would start trading better at some point."
He added that the recent strength in Golds will help Freddie to some extent, however, if the current refinancing wave is protracted, Freddie would be in danger of losing market share. This is because Golds are clearly cheap to Fannies and during a refinancing wave, there is more turnover going on and market share could change more rapidly.
With Freddie being more vigilant in their enforcement of delivery fees on A minus collateral, some observers say that they are moving in the direction of being "government-sponsored money managers," as one analyst described it.
And with BofA severing their exclusive alliance with Freddie Mac, there seems to be more evidence of Freddie's not pushing to correct Fannie's pricing advantage.
"BofA's move has to do with the fact that execution of Golds vs. Fannies is just very poor right now," another analyst hypothesized. "I guess BofA just got tired of biting the bullet. If you look at execution, why would anyone lock into a relationship where you are consistently getting inferior pricing?" The analyst suggested Banc of America may choose to eschew any new alliance, instead going with the best execution at any particular time.
That analysts explained that, theoretically, Golds should trade 5 to 6/ 32s over Fannies because they pay 10 days earlier. The 10-day difference is worth five to six ticks depending on the speed one uses on the coupon. However, Golds usually trade two to three ticks over Fannies at best.
Further, he said that the alliance system does not seem to be working at this point in time. "The economics of it made sense when it started in 1999 when everybody was fungible and execution was pretty consistent," he said.
There were also rumors in the market that a couple of large Freddie issuers were looking to get out of their exclusive agreements and might have actually done so without announcing it to the public. This might have happened sometime in January, thus affecting issuance figures. Analysts said that these issuers might be backing out of their agreements as negotiating tactics to get a better deal from Freddie.
Representatives from Freddie declined to comment on the rumors, but said that it is normal for month over month PC issuance to fluctuate and therefore could not be used as a reliable indicator. They added that Freddie's relationship with BofA is very important to the firm and the GSE still fully expects to do business with the issuer.
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