Fannie Mae, the largest non-bank financial services company in the world and America's largest source of financing for home mortgages, is approaching Asian institutional investors about investing in subordinated debt.
"Asian investors have become more sophisticated," says Linda Knight, senior vice president and treasurer. "They are investing in securities with longer maturities, in callable bonds, and are now considering subordinated debt and structured debt for their own portfolio needs."
The organization has $1,019 billion of assets and guarantees an additional $1.211 billion in outstanding mortgage-backed securities. Today, 16.4% of that is held by investors in Asia and Japan.
A growth area in this region is high-net worth individuals. Last year saw the first such clients from Hong Kong, and to an extent Singapore, become significant investors. Central banks, commercial banks and insurance companies are bedrock investors. Fannie Mae offers retail products in the United States but has no plans to do so in Asia.
Since 1998, Fannie Mae's funding strategy has been based on benchmark notes that are liquid and issued on a predictable schedule, so investors can buy in size (usually issues are $2 billion) and trade on the secondary market.
Fannie Mae will continue this strategy in 2004, but with two twists. First, it is going to decide maturities and other structures on the date the issue is announced, not ahead of time, to give it more flexibility to match market sentiment. Second, it is planning to issue sub debt but without announcing when.
"This is a capital strategy for our portfolio," Knight explains. The entity's capital and sub debt together make up 4% of Fannie Mae's assets, and it will issue sub debt to maintain that ratio as its asset base grows.
Asian investors are a big reason why its asset base is still growing. "The quantity of surpluses of US dollar holdings by Asian institutions is rising, creating a constant demand for high-quality investments in the US," says Franklin Raines, Fannie Mae's chairman and CEO.
Sub debt remains new to Fannie Mae's Asian investor base. It requires an additional layer of credit analysis. Fannie Mae's senior debt is rated AAA, while its sub debt is rated AA-. Knight is confident that Asian investors will easily move into this new class. "Many of them already buy corporate debt," she says. "Sub debt can add yield and although it gives investors some credit exposure, it's very high quality."
Although much has been written in the press (including FinanceAsia) about the imbalances of Asian central banks holding around $1 trillion of US bond issuance, Raines says there has been no sign that Asian investors will sell their Fannie Mae exposures. He acknowledges that if the dollar continues to plunge, demand may weaken. For now, however, Asians have no incentive to dump Fannie Mae bonds, because it would only appreciate their currencies.
Raines says the organization hasn't felt any impact as Asian investors diversify into euro-denominated bonds, particularly covered bonds issued by European mortgage or lending institutions, which are expected to issue up to Eur100 billion this year, according to FinanceAsia magazine.
"The US mortgage market is the world leader and there's been no reduction in demand for our securities," Raines says. "So while the euro is a more prominent currency for investors, it isn't at our expense." He says Fannie Mae has to compete by continuing to innovate, with longer maturities, callable bonds and now subordinated debt. "If the pricing is right," he adds, "we will issue in euros; if the execution is right, Fannie Mae securities can be available in euros."
In September of this year, Fannie Mae introduced a product called FX Discount Notes that invests in the short end of the Eurobond market, across a range of currencies from Europe, the UK, Switzerland, Canada, Australia, New Zealand, Hong Kong and Singapore. It allows the organization to trade during hours convenient to European and Asian time zones. Fannie Mae has so far issued the equivalent of $4.5 billion in various currencies.
Raines and Knight are touring Asia this week to meet with investors and hear their concerns. Most questions have centred on the future of the US housing market and the impact of rising interest rates.
Fannie Mae is painting a bullish picture. It expects mortgage debt to double by 2010 due to the growing US population, and it needs Asian investors to help it meet this demand. This decade the US will grow by 30 million people and up to 13 million households, and the mortgage market will expand from $7 trillion today to $11-14 trillion. Rising interest rates mean re-financings are tailing off; Raines says mortgage origination will be halved next year, but that purchases of existing mortgages will continue.
"We haven't had a bubble in US housing," Raines asserts, adding overall housing prices haven't declined since the 1940s, although localities have seen price drops. Prices continued to rise last year by 7%, and unless 10-year interest rates are jacked as high as 8%, he doesn't see a serious dampener on demand. Gradually rising interest rates make financing a house more expensive, but if those rate hikes are on the back of economic recovery, disposable income is higher.
"We assume the Fed will increase short-term rates in 2004 but from a very low base, and US mortgages are priced off the 10-year, not short-term rates," Raines says.