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Characteristics of Fannie Mae Debt Securities
Fannie Mae issues a variety of debt securities with maturities across the yield curve to fulfill its ongoing funding and rebalancing needs for the mortgage portfolio. Fannie Mae issues both short-term debt with maturities of a year or less and long-term debt with maturities of over a year. Typically, Fannie Mae debt can either be callable or noncallable. In recent years, additional structures and features have been added in response to investor needs as well as portfolio funding requirements.
Fannie Mae Noncallable Debt
Investors have found our noncallable or "bullet" securities attractive for their tradeability, liquidity, and price transparency as well as for the spread advantage they offer relative to comparable maturity U.S. Treasuries. Fannie Mae bullets typically have semiannual coupon payments, and principal is redeemed only at the stated final maturity date of the security.
Fannie Mae Callable Debt
Fannie Mae created the U.S. agency callable debt market in 1987. Callable debt plays an important role in helping Fannie Mae manage the interest-rate risk inherent in the mortgage portfolio, which is subject to prepayments from the underlying borrowers of the mortgages. The mortgages that Fannie Mae owns tend to prepay faster in periods of lower interest rate levels and prepay more slowly in periods of higher interest rate levels. Callable debt provides Fannie Mae with flexibility to ensure that the durations of our liabilities and of our mortgage assets are closely matched. By issuing callable debt, Fannie Mae is effectively buying a call option from investors and compensating these investors with additional yield above comparable maturity bullet securities.
Unlike some other agency issuers, Fannie Mae does not typically swap out of the call options on its callable debt, because these options are retained to hedge the prepayment risk inherent in the mortgage portfolio. The decision to redeem outstanding callable debt by Fannie Mae is a function of interest rate levels. We monitor our callable debt that is currently in its call period on a daily basis and determine whether it is economically feasible to call outstanding issues and replace them with other funding vehicles at lower yields. Callable debt securities are typically redeemed in whole.
Features of Callable Debt
The three main structural characteristics of our callable debt securities are the maturity date, the lockout period, and the type of call feature.
The maturity date of a callable debt instrument is the latest possible date at which the security will be retired and principal will be redeemed. Fannie Mae issues callable debt instruments with a variety of maturity dates along the yield curve.
The lockout period refers to the amount of time for which a callable security cannot be called. For example, with a 10 non-call 3-year ("10nc3") debt security, the security cannot be called for the first three years. Fannie Mae most often issues callable debt with lockout periods of greater than one year.
The call feature refers to the type of call option embedded in a callable security. Fannie Mae callable debt issues incorporate one of the following call features:
- Fannie Mae most often issues continuously callable or American-style callable debt that has a continuous call feature after an initial lockout period. The investor is compensated for this type of call feature by receiving a higher yield in exchange for allowing Fannie Mae the flexibility to call the security at any time after the lockout period with the requisite amount of notice given to the investor.
- Fannie Mae also issues callable debt with a one-time or European-style call feature. This call option can only be exercised by the issuer on a single day at the end of the initial lockout period. European-style callable securities provide the investor an opportunity to obtain a greater spread over a typical agency bullet of the same maturity while reducing the uncertainty of a continuous call. The spread of a European-style callable will, however, be somewhat lower than an American-style callable that has the same maturity and lockout period.
- The Bermudan-style callable debt security is callable only on coupon payment dates after the conclusion of the initial lockout period. Investors benefit from the increased predictability of cash flows and full coupon payments resulting from this structure. The spread of a Bermudan-style callable will be greater than the spread of a European-style callable but less than that of an American-style callable with the same maturity and initial lockout period.
As compared with other agency issuers, Fannie Mae offers the greatest diversity of callable debt products, in terms of maturity dates, lockout periods, and call features.
Strip eligibility
Some of our debt securities are eligible for stripping into principal and interest components through the Federal Reserve Book Entry System. All
of our Benchmark Securities are eligible for stripping. Investors often find strip eligibility attractive because of the flexibility it affords them in
cash management. Detailed information regarding strip eligibility can be found under the category Strip Activity.
Structured notes
The majority of Fannie Mae's debt securities carry a fixed interest rate. However, various step-up, variable-rate, and zero-coupon securities are available to investors. These structures typically have been issued on a reverse inquiry basis, in response to specific investor demand.
Step-up notes
These are variations of standard fixed-rate callable debt securities. The interest rate increases or "steps up" to a specified rate on one or more predetermined dates. Fannie Mae step-ups generally become eligible for redemption by Fannie Mae at the time of the first step-up. Notes that have more than one increase are called "multi-step-ups."
Variable-rate securities
These securities are divided into three broad categories and can be callable or noncallable:
- Simple index -- commonly used indices are three-month Treasury Bills, Prime, Daily Fed Funds, one-month LIBOR, three-month LIBOR, Weekly Fed Funds, and Weekly Constant Maturity Treasury.
- Calculated index -- these securities are more customized, generally to meet a specific investor's needs. Examples of these securities include:
Floating-rate notes with caps, floors and collars -- a maximum interest rate (cap), a minimum interest rate (floor), or both (collar) are added to a simple floating-rate note.
Inverse floating-rate notes -- also called inverse floaters, have coupons that periodically adjust in the opposite direction of the floating rate index. The coupon is derived by subtracting an index rate from a given fixed rate (e.g. 10 percent minus six-month LIBOR).
Deleveraged floating-rate notes -- the interest rate is computed as a fraction of an index (e.g. the Prime rate) plus a fixed percentage (e.g. a rate of 0.50 times Prime rate plus 0.50 percent).
Spread notes -- these securities pay a coupon computed as the difference between two rates plus a fixed percentage (e.g. Prime rate minus six-month LIBOR plus 2 percent).
- Complex calculated index -- these securities are often customized to meet the portfolio investment needs of a specific investor.
Cross currency dual index notes -- securities with an interest payment dependent on the relative performance of two or more indices, at least one of which is a non-U.S. Dollar currency or interest rate.
Zero-coupon securities
Fannie Mae also issues zero-coupon callable and noncallable securities. Zero-coupons are debt securities on which no coupon interest is paid to the investor. Rather, the security is purchased at a discounted dollar price and matures at par. If the option on a callable zero-coupon security is exercised, it is redeemed at a higher dollar price than the original issue price. The security's yield is based on the difference between the original discounted price and the principal payment at maturity date (or the call date, if the security is callable).
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Last Revised: June 16, 2009
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This document is for information purposes
only. It is neither an offer to sell nor a
solicitation of an offer to buy any Fannie
Mae security. Fannie Mae securities are offered
only in jurisdictions where permissible by
offering documents available through qualified
dealers. Securities issued by Fannie Mae are
not guaranteed by the United States and do
not constitute a debt or obligation of the
Unites States or of any agency or instrumentality
thereof other than Fannie Mae. All statements
made herein are qualified in their entirety
by reference in the applicable offering documents.
Securities discussed herein may not be eligible
for sale in certain jurisdictions or to certain
persons and may not be suitable for all types
of investors. An offering only may be made
through delivery of the Offering Document.
Investors considering purchasing a Fannie
Mae security should consult their own financial
and legal advisors for information about such
security, the risks and investment considerations
arising from an investment in such security,
the appropriate tools to analyze such investment,
and the suitability of such investment in
each investor's particular circumstances.
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