July 10, 2008 / 6:44 PM / 11 years ago

Protection costs soar for less secure Fannie, Freddie debt

NEW YORK, July 10 (Reuters) - The difference between credit spreads on less secure subordinated debt and safer senior debt of Fannie Mae FNM.N hit a record on Thursday amid a fresh wave of anxiety over solvency of U.S. mortgage giants.

Credit spreads on the subordinated debt of Fannie Mae and Freddie Mac FRE.N are widening faster than on senior debt amid increased worries about the ability of the two major U.S. mortgage finance companies to get the capital they need to survive.

Stoking concerns, former St. Louis Federal Reserve President William Poole said the two major U.S. mortgage finance companies were insolvent and may need a U.S. government bailout, according to Bloomberg News. For details, click on [ID:nBNG63700]

The outlook was so dire that Bush administration officials were meeting with regulators to discuss contingency plans should they be unable to raise funds and support the worst housing market since the Great Depression, according to a report in The Wall Street Journal.

“There is a lot of fear about the solvency of these companies,” said Tim Backshall, chief credit strategist at Credit Derivatives Research.

“The senior spreads are widening, but they are still being held back by the fact that the government has implicit guarantee, whereas the subordinated debt is a lot less likely to be taken care of in case of a credit event.”


Credit default swaps on subordinated Fannie Mae debt widened by 18 basis points to 240 basis points, or $240,000 to insure $10 million of debt for five years, while senior spread was little changed in afternoon trading at 80.5 basis points.

The difference between the two rose by 50 basis points this week as investors tried to profit from the market anxiety and hit a record of 160 basis points on Thursday, according to Backshall. That record was first set on March 14.

“There is a real solvency issue here and people are gambling on it, betting on it happening by using the differential” between senior and subordinated debt costs, Backshall said.

In afternoon trading on Thursday, credit default swaps on Freddie Mac’s senior debt were quoted at 80.5 basis points and on subordinated debt at 245 basis points.

Another sign of investor concerns about the risk to subordinated debt is the inverted curve for protection costs.

Typically long-term protection is more expensive than short-term protection, but the cost to insure Fannie Mae’s and Freddie Mac’s subordinate debt against default for one year is 300 basis points — higher than on five-year swaps, according to Phoenix Partners Group. (Reporting by Anastasija Johnson; Editing by Jan Paschal)

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