NEW YORK (Dow Jones)--Mergers in the financial services industry are leaving
Fannie Mae (FNM) and Freddie Mac (FRE) with fewer counterparties with which to
trade their rapidly growing derivatives books, market professionals say.
A key consolation, however, for those concerned about the potential for a
deterioration in credit risk for the two giant housing agencies is that
consolidation often boosts the credit ratings of the now bigger remaining
counterparties.
Whatever the net impact on the quality of the credit exposures at the two
government-sponsored enterprises', or GSEs, many analysts believe they should
at least provide better information on the subject.
There is no doubt about the importance of this issue. In order to lower their
cost of funding and to match their near $1 trillion combined mortgage assets
with their bond payment liabilities, the two agencies are increasing their
derivatives books at a pace that has led some analysts to raise concern about
systemic risks. It also dovetails with concerns noted in a section of the Bush
Administration's 2001 budget Monday, which said that the large size of some
GSEs is "a potential problem," posing systemic risks to financial markets.
In two years, Fannie Mae has more than doubled the notional amount of its
outstanding derivatives to $310 billion from $148.7 billion, and over the
four-year period to year-end 2000, Freddie Mac increased its notional book size
to $474.5 billion from $95.5 billion.
To be sure, the agencies use collateral and so-called netting agreements to
significantly reduce the net value of their credit exposures to levels much
lower than these notional amounts. According to Fannie Mae, its actual exposure
amounted to $0.2 billion at the end of 2000, while Freddie Mac said its
exposure came to $1.5 billion at the same date.
Still, with so many outstanding transactions in place, the GSEs' counterparty
relationships are attracting attention, as well as calls for improved
disclosures.
Freddie's Shrinking Disclosures
For its part, Freddie Mac has in three years of annual statements restricted
the information it offers on counterparty exposures to an increasingly smaller
portion of its portfolio.
In its information statement released last week, the company said "At
December 31, 2000, the three largest counterparties (based on notional or
contractual amounts), each with an independent credit rating of `A-plus' or
better, accounted for approximately 39 percent of the notional amount of the
corporation's outstanding over-the-counter derivative financial instruments."
In the comparable disclosure for year-end 1999, Freddie cited four
counterparties with ratings of A-plus or better accounting for some 54% of the
notional amount, while in 1998 it cited five such counterparties which
accounted for 60%.
A spokeswoman for Freddie Mac said the "figures really aren't related to
consolidation of counterparties."
"It's not a pattern," she said, arguing that the changes seen in the series
of disclosures simply reflects the specificity of the reporting date. They "are
snapshots at a point in time on a given date," she said.
One long-time agency watcher is concerned by such inconsistencies in the
quality of the GSEs' counterparty disclosures.
While Fannie Mae and Freddie Mac have been trumpeting their own initiatives
toward greater corporate transparency, "I don't see overall materially improved
disclosures in regards to derivatives exposure and counterparty credit risk,"
said Bert Ely, a principal at Ely & Co., a financial advisory firm in
Alexandria, Va.
As for Fannie Mae, it cut out a piece of derivative counterparty information
in its most recent information statement, opting not to disclose the percentage
of its business conducted with companies rated double-A or better.
Fannie Mae"Arbitrarily decided to drop the reference to double-A rated
entities," said Robert McCarson, a spokesman for the housing enterprise.
In fact, McCarson told Dow Jones Newswires that as of December 31, 2000, 74%
of the total notional amount of Fannie Mae's derivatives was held by companies
double-A rated or better. That's slightly higher than the 72% figure from the
year prior, and up from the 68% in 1998 and 67% at the end of 1997.
Fannie Mae's derivatives transactions with companies carrying at least a
single-A rating has also been growing, from 91% of its total notional principal
at the end of 1997 to 99% at the end of 2000.
Financial Ratings Higher
One trend in the agencies' favor is that credit ratings in the banking sector
have generally tended to move higher over the past five years.
"Mergers and acquisitions have played a major role in boosting the credit
ratings among major banks," said John Lonski, chief economist at Moody's
Investors Service.
J.P. Morgan, for instance, was rated single-A1 prior to being acquired by
Chase Manhattan. Even before the joined forces, both Chase and J.P. Morgan were
heavy hitters in the derivatives market. The combined entity is now a veritable
behemoth in the industry, and carries a double-A3 rating from Moody's.
This and similar upgrades are likely one factor in the higher percentage of
Fannie Mae derivative transactions conducted with single- and double-A
counterparties, said Larry Dyer, agency strategist at Credit Suisse First
Boston.
"The average counterparty probably is a better credit than it was three or
five years ago," he said.
And while a shrinking number of players likely means less opportunity to
diversify, Fannie Mae doesn't sound concerned.
"I would argue that we're better managers of that risk than banks and thrifts
because that's all we do," company spokesman McCarson said. "We're actually a
relatively small player in the derivatives market," he added, noting that there
are some banks with far larger derivatives exposure.
Moreover, he said, "Our counterparties are very diversified. We have more
than two dozen."
Yet Fannie's most recent information statement shows that more than 99% of
its notional amount of derivatives were held by only nine counterparties at the
end of last year. Additionally, 99% of the company's gross off-balance sheet
exposure to derivatives - a better measure of Fannie's overall risk exposure -
was held by only five counterparties.
"Five years ago it would have been double that number," another long-time
professional in the agency debt market said of Fannie Mae's five counterparties
for its off balance sheet exposure. |
