US CREDIT-Fannie Mae credit spread blowout may be opportunity
NEW YORK, Feb 19 (Reuters) - The cost to insure the debt of mortgage finance company Fannie Mae (FNM.N) is near all time highs, and any volatility around its earnings may present a good opportunity to sell protection on the company.
The cost to insure Fannie Mae's debt with credit default swaps jumped to a new high of 77.5 basis points on Tuesday, or $77,500 per year for five years to insure $10 million in debt, according to Markit Intraday. It has risen from 56 basis points at the beginning of February and 39 basis points at the beginning of the year.
"Agency credit default swaps have widened out in sympathy with the barrage of negative news, including losses at mortgage insurers, fear of woes spreading into the prime mortgage market, and credit spreads at historical wides," Citigroup analysts said in a report sent on Tuesday.
"We believe that the spread widening is overdone and does not reflect how the two government sponsored enterprises (GSEs) stand to benefit from the turmoil in the housing and credit markets," they said.
Much of the widening in credit default swaps on Fannie Mae, the largest U.S. mortgage finance company, has been for technical reasons, rather than concerns about the credit quality of the company, Credit Suisse analyst Ira Jersey said.
"Its almost trading more on counterparty risk than it is on the underlying fundamentals of the actual credit, and in relation to swap spreads being wider," he said.
Swap spreads have widened and counterparty credit risk has come to the fore as banks write down large losses from risky residential mortgage backed debt, and bond insurers risk losing their top ratings on exposures they also have to mortgage-backed debt.
GSEs are also exposed to bad mortgage-backed debt, however as mortgages in their portfolios mature they also have the opportunity to add new exposures at more favorable spreads, Jersey noted.
"And as all the subprime stuff rolls off, they'll continue to do better," he said.
The Office of Federal Housing Enterprise Oversight, which regulates GSEs, also said earlier this month that it is talking with the companies about lifting a demand that they hold 30 percent more capital than normal. This requirement was placed on them due to accounting scandals.
"Getting rid of the regulatory surcharge is an interesting concept because it basically allows them to take more writedowns without having to raise capital," Jersey said.
EARNINGS RISKS
However, even while swaps are trading at historical highs, headline risk remains a major headwind.
"There is a big risk here, and that risk is that both of them do have subprime and Alt-A (mortgage) exposure and if they have to write down some of that exposure their earnings will be bad and that'll create some volatility," Jersey said.
Fannie Mae in November said its third-quarter net loss doubled from the previous year as slumping home prices and a credit squeeze drove down values of mortgage securities. For details, see [ID:nN09377585]
Jersey is "marketweight" Fannie Mae's credit default swaps, but views one possible way to benefit from wide spreads as selling protection with credit default swaps at the same time as shorting its stock, or buying equity put options.
Credit Suisse equity analysts having an "underperform" recommendation on Fannie Mae's stock, he said.
Citigroup, meanwhile, recommends selling protection at current levels, and doubling up on the trade if spreads widen to 90 basis points on weak earnings.
The bank views a potential gain of 35 basis points from the trade, and recommends setting a stop-loss of 30 basis points on the average entry level into the trade.
(Reporting by Karen Brettell; editing by Clive McKeef)
