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The 800-Pound Gorilla In Fixed Income's Corner

The implosion of the U.S. subprime-mortgage market left many banks crying uncle — Sam, that is.

The implosion of the U.S. subprime-mortgage market left many banks crying uncle — Sam, that is. The Bush and Obama administrations responded with the Term Asset-­Backed Securities Loan Facility, the Troubled Asset Relief Program and other packages, allocating more than $1 trillion to ailing institutions, including the Federal National Mortgage Association and the Federal Home Loan Mortgage Corp.

“Without the massive government intervention, Fannie Mae and Freddie Mac would be insolvent,” insists Margaret Kerins of RBS Securities, who captains the top team in Federal Agency Debt Strategy for a third straight year. The Chicago-­based strategist notes that the Federal Reserve Board and the Treasury bought $767 billion in mortgage-­backed securities this year through late July.

The purchases have served to reduce the spread between agency debt and Treasuries. Last month, after the Federal Reserve reaffirmed its plan to buy nearly $500 billion more in MBSs by December 31, the spread between Fannie Mae’s 30-year 4.5 percent bonds and ten-year Treasuries narrowed by 2 basis points, to 93. Kerins says she expects the narrowing “to take a pause here,” although she predicted that government support of the mortgage market would continue into 2010. Sure enough, several weeks after Kerins was interviewed, the Fed and the Treasury announced plans to extend most TALF programs at least through March.

Matthew Jozoff of J.P. Morgan shares a similar view. The New York–based analyst, who leads or co-leads four No. 1 teams — MBS/Adjustable-­Rate Mortgages, MBS/Agency Pass-Throughs, MBS/Agency-­Structured Products and MBS Strategy — notes that spreads tightened by roughly 75 basis points in the first seven months of the year, and he expects the rest of 2009 to reflect a less volatile, more value-driven agency market.

Although residential real estate may be showing signs of stabilizing, commercial real estate is not. Alan Todd, who steers the J.P. Morgan team from second place to first in Commercial Mortgage-Backed Securities, expects the number of defaults to rise in the near term and pressure on fundamentals to intensify. “There will be continued bad news for the next year or two,” says Todd, who also is based in New York.

Real estate investment trusts — which were hammered in the fourth quarter, recovered some lost ground in the first quarter, then got beat up again in March — raised $16 billion in common equity and $10 billion in debt capital this year through July, according to Thierry Perrein of Wells Fargo Securities, the sector’s top-­ranked researcher for a second consecutive year. MSCI’s REITs index was up 60.5 percent from its 2009 low, but don’t expect the gains to continue, Perrein says. Lasting recovery will lag the economy and fundamentals will continue to erode through 2011, the Charlotte, North Carolina–based analyst believes. He is telling investors to take a break at this point: “You can’t be too greedy,” he says.

See related article, "Credit Markets Show Signs of Life".

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