Agencies tighter amid Fed buybacks on active Friday; Barclays sees Fannie sub-debt offer

By Kenneth Lim

Boston, July 17 - Bullet agency spreads were mixed to a little tighter on an active Friday as the Federal Reserve absorbed some supply through its buying program.

Meanwhile, a research report by Barclays Capital said there is a "non-trivial" chance that Fannie Mae could follow in the steps of Freddie Mac and tender for its subordinated notes.

"I'd say today for a Friday was pretty busy, a fair amount of activity," said Jefferies & Co. head of U.S. government agency Michael S. Effron.

Bullet spreads were slightly narrower because of the Fed's buying of agency notes on the long end of the yield curve, while callable spreads followed Eurodollars wider on the day, Effron said.

The Federal Reserve Bank of New York said Friday it bought $1.175 billion of agency securities on the open market, just under 50% of the $2.42 billion in bids received. The Fed bought agency securities due 2016, 2017, 2018, 2030, 2031 and 2032.

Volume was robust for a summer Friday, and Effron saw the rates back-up as the main driver.

"I think accounts have some money to put to work in here," he said. "We've had a back-up in rates, so they are taking advantage of the back-up to take some positions."

FHLB to announce

Federal Home Loan Banks has an announcement of Global bullets slated for Tuesday. The agency in June priced an oversubscribed and upsized $5 billion of 1.625% 2-year Global notes.

The market will be watching to see how well the deal goes and how much FHLB decides to raise, Effron said.

"I think there's trades to be done in the week ahead," Effron said. "I think a lot of it is going to be dependent on the funding need of the GSEs."

Barclays sees possible Fannie tender

Fannie Mae could potentially follow Freddie Mac and tender for its subordinated notes, Barclays analysts Rajiv Setia, James Ma and Philip Ling said in a research note.

Freddie Mac on July 10 offered to buy back all its $4.39 billion of outstanding SUBS subordinated securities at a significant premium to market levels - about 50 to 90 basis points, according to one trader.

The agency is offering to buy its $1.09 billion of 5.875% Freddie SUBS due March 21, 2011 at a spread of 100 basis points over Treasuries, $1.25 billion of 5.75% Freddie SUBS due June 27, 2016 at a spread of 125 bps and $2.05 billion of 5% Freddie SUBS due Dec. 14, 2018 at a spread of 125 bps.

Goldman, Sachs & Co. is the lead dealer manager with Banc of America Securities LLC and Citigroup Global Markets Inc.

Given the small size of the market segment and the hefty premium, "the tender offer's success has basically been assured," the analysts wrote.

Holders who reject the offer also risk interest deferral at the expense of better value elsewhere, such as investment-grade credit at 200 basis points over Treasuries, the analysts added.

The reasons that Freddie Mac wants to take out the SUBS - obsolescence, high interest costs and potential economic gains - also apply to Fannie Mae, and the possibility of a similar offer by Fannie Mae is "non-trivial," the analysts wrote.

Prices of Fannie Mae subordinated notes have been pushed up by the Freddie Mac offer, but there is still room on the upside because the market is uncertain about a Fannie Mae program.

If there is a Fannie Mae offer, "we would expect FNM to offer a premium to these market prices, potentially even better than the spreads offered by FRE," the analysts wrote.

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