After Fannie Mae's announcement on Friday, April 14 at 5:45 PM EST that it was rescinding the clean-up call of MBS worth roughly $1.5 billion of unpaid principal, most of the MBS market was relieved. However, some mortgage participants who undertook transactions in reaction to Fannie's earlier plan to exercise the clean-up call were understandably irate, while others were speculating as to the reasons behind Fannie's sudden change of heart.
A senior MBS market observer told ASR that there is pretty good hearsay evidence that the original decision was made without telling Fannie Mae Chairman and CEO Franklin Raines. Another possibility, he said, was Raines may have known about the move but did not fully understand the implications of the clean-up call for the MBS market. He added that people below Raines' level made "a kind of narrow economic decision to call these pools."
"I think they underestimated how disruptive this was going to be to the market," the source noted. Fannie Mae's move caused so much commotion that some institutional investors actually went to the Office of Federal Housing Enterprise Oversight (OFHEO) to complain while some members of Congress who have anti-GSE leanings started making noises (see ASR 4/15/02 p. 13), saying that maybe all of Fannie and Freddie Mac's issues - which are currently exempt from normal Securities and Exchange Commission (SEC) registration - must be subject to this requirement.
With the uproar that followed the move, Raines is said to have acted immediately to curb growing anti-Fannie sentiment and chose to undo the call.
"Mr. Raines probably figured that the $120 million to $130 million revenue or economic value that Fannie would have gained by making the calls was not worth the political ill will," the senior market observer said. "Fannie's charter comes from Congress and may be changed by Congress, so Fannie is really somewhat of a political institution. So I think that Mr. Raines, who is politically astute, saw that the revenue was not worth it. I think it was his decision to undo the clean-up call."
Others, however, said that the rescission may not have been solely driven by political motives, but was also a strategic business decision.
Street research mentioned that the senior management at the firm was probably concerned about the effect that the calls may have on Fannie MBS and was also worried about the possibility of creating a multi-tiered market for FNMA TBAs.
Market experts stated, for instance, that the calls were going to create problems on how premium TBAs were delivered. The question was whether investors would accept those pools as good delivery under TBA guidelines.
The Bond Market Association was already discussing the possibility of declaring those Fannie pools with 10% calls not good delivery. And even if the BMA had not acted, experts said that investors who bought Fannie 8s or 8.5s were likely to make WAM stipulations on their Fannie premium purchases. This would have effectively made the market for Fannie seasoned premiums quite illiquid.
"Fannie premiums were going to have to be repriced," said an MBS analyst. "If Fannie pools are callable and Freddies are not, then Freddie premiums would be worth more relative to Fannie premiums and that would have been a problem."
Investors said that this could have threatened Fannie Mae's status as the benchmark security. They added that as much as Freddie tries to market itself, traders on the Street still look at Freddie securities vs. the price spread to Fannie Mae.
Lack of information
Though investors admit that Fannie Mae was helpful in disclosing information to them, some Wall Street analysts complained that the agency was not as forthcoming with information.
One MBS strategist said that Fannie was not even being truthful when it said (as part of its release announcing the elimination of the clean-up call), "On April 4, 2002, Fannie Mae announced a plan to exercise a clean-up call of MBS totaling approximately $1.5 billion of unpaid principal."
"They said that they announced a call. That's not accurate," groused the strategist. "They never announced anything. They merely announced the factors and everybody else sort of figured it out. Somebody in Fannie Mae acknowledged it off the record but they didn't put up anything on their Web site until Thursday April 11 at 7:15 AM."
Investors said that the information on the Fannie Mae call was in the firm's documents pre-1993. But Fannie's Web site did not even have any documents pre-1994. So investors, in effect, did not have access to the documents where this call provision was actually allowed. In contrast, for the last ten years, everybody was fully aware of the clean-up call in the Freddie Mac REMIC. However, as far as Fannie Mae went, nobody really knew about a clean-up on Fannie's REMIC and CMOs, so no one's analytics included this clean-up call.
But, with all this being said, Fannie was supposedly very pro-active in giving investors the necessary information.
"I would say that as an end buyer - not being a Wall Street firm or the media - we had a good call into different people and they were trying to be helpful," said an investor. "They are a large corporation but they were concerned and they were trying to help out by trying to be as forthcoming as possible."
However, it was hard to really give investors everything they wanted because many were asking for specifics such as which bonds were callable and when exactly were they going to be callable. Though Fannie Mae obviously had all the data already compiled, it was hard for them to disseminate the information to every investor that wanted it.
"I do not think they were trying to be stingy," said the investor. "They were just not at the point where they could do it for me or any investor without trying to figure out how they could do it for everyone at one time."
Losses to investors
According to some buysiders, it was the smaller investors who probably took the hit when Fannie announced the clean-up call.
One investor said that although there would have been some market value losses for a few investors, "a lot of these bonds were museum pieces that were bought about 15 years ago and were bought at a discount. Therefore, at a value basis, it would have been a non-event."
However, from a total-return standpoint, if an investor is pricing a bond at 100.05 or 100.10, and it gets called at par, it could be very frustrating. But he added that there did not seem to be a very large concentration of these in any of the big-name investors. However, there were a few smaller regionals that have been trafficking into seasoned paper that actually placed some of these bonds more recently and some people actually paid 100.05 to 100.10 dollar prices on these securities.
But what most investors were really complaining about was the hassle of having to get underneath what the call option was in every pool they owned.
"It is not as if one could isolate the 10% coupon that was issued in 1987, but you have to look at all pools from 1981 to 2001," said the investor. "It is still a headache because right now our back office is going through the process of undoing all the existing factors and redoing the new factors based on where things were called and not called. It also had an impact on some of the seasoned CMOs."
Reminiscent of Freddie
Observers said that Fannie Mae's announcement of the clean-up call is reminiscent of when Freddie Mac changed its reporting schedule almost the same time last year. Freddie also got a lot of heat when they announced the change.
However, there were a few advantages that Freddie had in its favor. According to an MBS strategist, one could really point to some tangible benefit for the market as a whole in standardizing reporting guidelines. Secondly, Freddie announced it up front and "they answered questions, they returned phone calls and posted the necessary information while Fannie did this all surreptitiously," he stated.
Aside from this, Freddie's action had the potential to benefit the way the secondary market traded, which was the exact opposite of the effect Fannie Mae's decision would have had.
But analysts also say that investors' memories are short, and people are not really going to view Fannie securities any differently, especially after the agency rescinded the call and said that there would not be any further clean-up calls going forward.
"You only have lingering investor resentment, but you have no actual economic reason to discount their securities," said another MBS analyst. "What I personally learned last year after Freddie Mac's accounting change is investors get upset for a couple of months and then they sort of forget about it and go back to normal. So I don't particularly see any long-term ill to Fannie Mae from this other than them sort of looking foolish because of what they did.