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By Damian Paletta and Serena Ng, WSJ | 20 September 2007
- The Federal Reserve's rate-cut medicine revived corporate debt markets yesterday, as the Bush administration sought to give the nation's weakened housing market a boost by backing modest expansions in the powers of mortgage giants Fannie Mae and Freddie Mac.
The Donnelley sale marked the first significant junk-bond sale since the summer drought, which was marked by more than 50 postponements of junk-debt offerings.
The stock market also got a lift, with the Dow Jones Industrial Average rising 76.17 to 13815.56, continuing the robust rally started by the Fed's interest rate cut and putting it up 11% for the year.
The most significant moves continued to emanate from Washington, where rising default and foreclosure rates are putting pressure on the government to act. A critical issue is whether Fannie Mae and Freddie Mac, government-sponsored enterprises, should be allowed to purchase mortgages above the current $417,000 conforming loan limit. Currently, the two mortgage-finance companies can only acquire home loans below this limit, while Wall Street firms have traditionally played a more active role buying and securitizing large, or jumbo, mortgages.
This issue is crucial because the market for jumbo mortgages has seized up, and a lack of funding for these more expensive loans could have a major impact on housing values in large U.S cities. There is strong pressure in Congress to loosen the reins on Fannie and Freddie even more in the current housing downturn.
The Bush administration, which has tried to rein in Fannie and Freddie, eased its position in light of the credit crisis. "There is little question that allowing the GSEs [government-sponsored enterprises] to securitize jumbo mortgages would give a short-term lift," Treasury Secretary Henry Paulson is expected to tell the House Financial Services Committee at a hearing today, according to prepared remarks. He is expected to say, however, that it would be "unreasonable and irresponsible" to expand their businesses without addressing their regulatory problems.
Mortgage Limits
After The Boom: Delinquency Rates, Key U.S. Areas, Second Quarter, 2007
Federal Reserve Chairman Ben Bernanke appears to be opening the door to temporarily allowing Fannie and Freddie to purchase mortgages above the current limit. Mr. Bernanke sent a letter Monday to House Financial Services Committee Chairman Barney Frank (D., Mass.) saying that if Congress is inclined to raise the limit it should consider doing so in a way "that makes the change explicitly temporary as well as promptly implemented." Mr. Bernanke stopped short of endorsing the idea.
As the Bush administration's position on the issue continues to bend, the top officials at Fannie Mae and Freddie Mac are expected to go on the offensive today as they appear before the same committee. Freddie Mac Chief Executive Richard Syron is expected to say that a temporary lifting of the limit would "provide needed liquidity," according to prepared remarks.
In another sign of an administration shift, the regulator for Fannie Mae and Freddie Mac, the Office of Federal Housing Enterprise Oversight, agreed to relax restrictions on the mortgage-finance companies' investment holdings. OFHEO's new policy allows Fannie Mae to increase its portfolio by 2% a year, a level comparable with an existing limit on rival Freddie Mac.
The move could allow the companies to add a combined $40 billion in mortgages to their portfolios by the end of March. In making the changes, OFHEO cited recent progress by both companies in repairing internal controls, though it pointed out that neither company had returned to timely filing of financial statements from past accounting scandals.
Fannie Mae called on the regulator to allow bigger increases. "We still believe the more effective response, given the extent of the market disruption, would be to raise our portfolio cap by at least 10%," Fannie Mae spokesman Brian Faith said.
The cascade of positive news was well-received by the parched credit markets, pushing yields on corporate bonds and loans lower. The market for asset-backed commercial paper, which seized up a few weeks ago and had been threatening to create funding problems for many financial institutions, also improved.
The Fed rate cut triggered a 0.35-percentage-point drop in the one-month London interbank offered rate to 5.15%, a development that should help improve liquidity in the money markets. The three-month Libor, which many leveraged-buyout loans are pegged to, fell to 5.24%, down sharply from more than 5.7% earlier this month. Libor had hit a multiyear high after this summer's liquidity crisis reduced the willingness of banks to lend money to each other.
"There's been a 100% change in sentiment," said Marc Frank, a bond trader at Group G Capital Partners LLC, a New York hedge fund. "The feeling is that money may be getting cheaper, and some large buyout loan financings can now get done."
Still, investment banks that need to sell more than $300 billion of debt from leveraged buyouts they are financing in the coming months are treading carefully. They are opting not to sell too much debt at the same time. Many investors worry that a flood of issuance could push down prices of many other bonds and loans. Bond prices move in the opposite direction as yields.
Wall Street banks are currently seeking buyers for a $5 billion loan for First Data Corp., part of $24 billion in debt financing for the deal. The banks will likely keep most of that debt on their own books for the time being.
Takeover Financing
Debt Dilemmas
Yesterday, another group of banks began marketing a $3.15 billion loan that will help finance the $15.2 billion acquisition of apartment giant Archstone-Smith Trust by Tishman Speyer Properties and Lehman Brothers. Underwriters are also close to selling an additional $500 million in loans for Allison Transmission Inc. after having sold $1 billion in debt for the auto-parts maker last week, according to Standard & Poor's Leveraged Commentary & Data.
While the Fed's rate cut helped to unfreeze pockets of the credit markets, some investors worried the Fed's aggressive stance is an acknowledgment of signs of weakness in the economy. The housing market is still eroding, as home-loan delinquencies and defaults continue to rise.
"We're seeing a lot of encouraging signs that the gears are starting to turn again in the credit markets, but there's still a lot of skepticism around," said Derrick Wulf, a portfolio manager at Dwight Asset Management in Burlington, Vt.
Attracting Funds
Some investors also remain concerned that so-called SIVs, or structured investment vehicles, are still having difficulty attracting investment funds. That could leave some of these vehicles unable to pay off liabilities in coming months. "Conditions have improved broadly, but it's still a bifurcated market," said Ron Flynn, an executive director at J.P. Morgan Chase & Co. who trades in the short-term debt markets.
Still, the broader commercial-paper market improved. The average yield companies pay on 30-day asset-backed commercial paper dropped to about 5.3% by late afternoon, down from nearly 6% just before the Fed move, according to UBS interest-rate strategist Mary Beth Fisher. The average yield on overnight financial commercial paper fell to 4.75%, down from just over 5% before the Fed cut, she said.
"Everything is improving," Ms. Fisher said. "But the liquidity crisis hasn't passed yet."
In the U.S., an affiliate of British bank HBOS PLC was able to sell $2 billion in short-term debt on Tuesday and around $1 billion yesterday. In August, HBOS had to step in to cover the maturing debt of the affiliate after it couldn't roll over its commercial paper.
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