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No need to worry about Fannie and Freddie bonds

By Sheyna Steiner · Bankrate.com
Friday, November 12, 2010
Posted: 11 am ET

Fannie Mae and Freddie Mac have been in the news more than Lindsay Lohan since they were placed in conservatorship in 2008. What does that mean for bond investors?

Most recently, ratings agency Standard & Poor's reported that overhauling the Federal Home Loan Mortgage Corporation, aka Freddie Mac, and the Federal National Mortgage Association, aka Fannie Mae, could cost taxpayers as much as $685 billion. Hundreds of billions of dollars may be spent rescuing them and then the overhaul process begins, which may entail outfitting entirely new entities to take their place, the Wall Street Journal reported November 4.

Freddie Mac and Fannie Mae are publically traded companies that buy mortgages from banks and package them into mortgage-backed securities which are then sold to investors.

They also issue debt securities. Because of their status as government-sponsored enterprises, bonds issued by Fannie and Freddie have extremely low credit risk. They are considered slightly more risky than U.S. Treasuries. That credit risk remains low despite the ongoing negative news about the two agencies.

"Noncall agency paper has tightened to the curve over the last year or so, implying that there is less credit risk now rather than more credit risk now. Callable agency paper is the same," says Donald Cummings Jr., managing partner at Blue Haven Capital in Geneva, Ill.

"I tend to look at the relative spread market to gauge risk, and since spreads are well within the range of the last 52 weeks, I would say the market is not worried about the creditworthiness of agency paper," he says.

In other words, agency debt securities, or bonds, are trading at yields closer to comparative Treasuries. The credit spread is based on the creditworthiness of the issuing institution. The credit spread widens as risk increases.

So, despite daily dissections in the news, investors in debt issued by Fannie and Freddie can rest easy.

 Jim Wright, chief investment officer at Harvest Financial Partners in Paoli, Penn., uses callable agency bonds as a way to enhance cash returns.

"Because they are callable, they will trade with a bit of a premium," he says. "If you buy them in the secondary market, you can find yields to call that could be substantially higher than a comparable Treasury or non-callable agency. You don't know if they'll call it or if it will go to maturity."

Would you be worried if you held a debt security issued by Fannie or Freddie?

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