Presentation on theme: "1 1 1 GIOA Conference March 2011 - Las Vegas Callable Debt Workshop Jim Zucco – Director Funding Fannie Mae Treasury."— Presentation transcript:
1 1 1 GIOA Conference March 2011 - Las Vegas Callable Debt Workshop Jim Zucco – Director Funding Fannie Mae Treasury
2 2 2 To maintain our asset/liability match, Fannie Mae uses option embedded debt along with actively rebalancing the portfolio. Source: Fannie Mae, Barclays Capital * As of January 31, 2011 Duration of MBS Component of Barclays Aggregate Fixed-Income Index Fannie Mae Duration Gap
4 4 4 Structural Features of Callable Debt Maturity Date The latest and final possible date at which the security will be retired and principal will be redeemed at par. Lockout Period The amount of time for which a callable security cannot be called. For example, with a 3 noncall 1-year (“3nc1”) debt security, the security cannot be called for the first year. During this time, only coupon payments are made Type of Call Feature The type of call options embedded in a callable security Fannie Mae issues callable debt instruments with a variety of maturity dates along the yield curve. Fannie Mae issues callable debt with lockout periods of three months to as long as 10 years. Fannie Mae callable debt issues incorporate one of the following call features (after the lockout date): 1)American-style (continuous); 2)European-style (one-time); 3)Bermudan-style (only on a predetermined schedule of dates); 4)Canary-style (on a predetermined schedule of dates until designated called period ends).
5 5 5 Fannie Mae’s flexible, responsive, and efficient reverse inquiry process InvestorDealer Fannie Mae’s Long Term Funding Desk 1-5 minutes Maturity 1-year to 30-years Lockout 3-months to 10-years Call Option European Bermudan American Canary Customized Callable Debt Security (~ 50 firms) Coupon Fixed-rate Floating rate Step-up Float-to-fixed
6 6 6 Callable Medium-Term Notes (MTNs) Issuance by Call Feature Source: Fannie Mae, Bloomberg * As of February 28, 2011
7 7 7 Callable MTN Issuance by Maturity Bucket Source: Fannie Mae * As of February 28, 2011
8 8 8 (in millions) Callable MTN Issuance by Lockout Period Source: Fannie Mae * As of February 28, 2011 2011*
9 9 9 Total IssuanceNumber of Transactions Fannie Mae is focused on the issuance of callable MTNs that are $250 million or larger issue sizes with multiple dealer underwriters* * Callable MTNs from January 1, 2011 to February 28, 2011, three callable issues were $1 billion or larger in size totaling $3 billion. Source: Fannie Mae
10 Callable notes outstanding varies over time but is relative to overall assets held on balance sheet Source: Fannie Mae Y/E Balance (Blns) Projected Balances – 10% Reduction
11 Through a combination of lockout and maturity, Fannie Mae issues different structures that offer a variety of risk profiles Source: Fannie Mae
12 How do we value and price callable debt? From our perspective, a five year maturity where we have the ability to call the note in one year with four years remaining. Hence, valuation components are two fold: * Our bullet cost of funds, one to five years. * Cost of the option that allows us to call a four year bond, one year forward. This is where it gets more complicated……
13 Bullet and callable spreads for 5 Y bullet and new issue 5nc1Y 1X callable note Callable spreads are driven by those two factors, 5 Y bullet spreads and the value of the call option. Source: Fannie Mae
14 No market for options on Agency rates…..we utilize option pricing on swap rates as the two markets are highly correlated Source: Fannie Mae
15 Option terminology…. Black (Yield) vol: Market quoted implied volatility used to translate volatility to price Normal (BP) vol: Yield volatility multiplied by the forward rate. A measure that “normalizes” yield volatility with level of rates. 5nc1 Y Example…. Forward Rate…. As implied by current yield curve. Volatility quote is based on the strike set at the forward. Implied volatility sets the expected range of future rates. The higher the volatility assumption, the wider the expected range.
16 The Call Spread is dictated by the volatility assumption that is used to value the embedded option. Source: Fannie Mae
17 Calculating the par priced, callable bond coupon is an iterative process. The coupon (strike) where the value of the high coupon bullet is offset by the value of the option. Source: Fannie Mae Market InformationCoupon Bullet Price Option Value Callable PriceDurationConvexYTMYTC 1 Year Agy0.31%3.25%102.9(2.0)101.52.6(1.18)2.93%1.75% 4 Year Agy2.00%3.00%102.3(1.5)100.83.0(1.22)2.82%2.16% 5 Year Agy2.51%2.72%101.0(1.0)100.03.3(1.17)2.72% 1x4 Forward3.09%2.50%99.9(0.7)99.33.7(1.06)2.66%3.26% ATM Vol112.6 BPs2.25%98.8(0.4)98.34.0(0.86)2.61%3.96% Black Vol36.4% 5nc1Y 1X Callable Pricing (as of 3/3 rd )
18 The relationship of the callable coupon to the forward rate (“Moneyness”) is driven by shape of the curve. Source: Fannie Mae
19 “Moneyness” can dictate the overall risk profile of the callable note….duration measure. Source: Fannie Mae
20 “Moneyness” can dictate the overall risk profile of the callable note….convexity measure. Source: Fannie Mae
21 Bermudan pricing is the same process, the only difference is the use of a volatility surface instead of a single volatility assumption. Source: Fannie Mae The Bermudan volatility for a 5nc1Y is 32.1% compared to 36.4% for the 1X callable. However, the Bermudan coupon is still 6 BPs higher than the 1X bond.
22 Different sectors of the volatility surface reflect the market’s view on future rates and monetary policy. Source: Barclays Capital
23 Implied volatility levels fluctuate with rate levels though the relationship has reversed since 2009. Source: Barclays Capital
24 The volatility on strikes that are not ATM can vary. Below is 1x4 normal volatility with strikes +/- 200 bps. Source: Fannie Mae The difference between the ATM volatility and the one used for varying strikes is referred to as “skew”. Right now, high (low) strikes trade at a higher (lower) implied volatility compared to the ATM. AOAS is set to normal volatility.
25 Will a bond be called? European, fixed rate note… Source: Bloomberg Assumptions Discounting curve: I252 (Fannie Mae Benchmarks) via AOAS Call price: Par (100) Settlement:Call Date Volatility assumption: Zero Call decision:Positive (negative) OAS – bond is called (extends)
26 Will a bond be called? Bermudan, step-up….. Source: Bloomberg Assumptions Discounting curve: I252 (Fannie Mae Benchmarks) via AOAS Call price: Par (100) Settlement:Next Call Date Volatility assumption: Volatility surface – Bloomberg Model H Call decision:Positive (negative) OAS – bond is called (extends)