Fannie and Freddie’s hedging rockets in 2001

Fannie Mae and Freddie Mac’s first detailed disclosure of their derivatives positions has revealed a dramatic increase in hedging activity by the two US federal-backed mortgage companies.

The total notional value of Freddie’s derivatives position increased to $1.05 trillion in 2001, a 120% increase on the previous year. Fannie’s derivatives notional was up 65% to $533 billion for the same period.“Transparency helps investors see Fannie Mae as a company that manages risks well,” said Franklin Raines, Washington DC-based chief executive and chairman of Fannie Mae. All of Fannie’s derivatives trading is over-the counter (OTC), with just five counterparties rated single-A or better, accounting for 98% of its exposure.

Around $661 billion of Freddie’s derivatives notional was traded OTC. Its counterparty default risk exposure was only $69 million, while Fannie’s figure was around $110 million.

Increased issuance of short-term debt by Freddie and Fannie precipitated greater use of swaps and swaptions to manage duration, and better match assets and liabilities on the back of a steepened US yield curve.

For example, when issuing short-term debt, Fannie would typically enter into 10-year swaps where it receives floating rate. Alternatively, if Fannie wanted to synthetically replicate 10-year callable note issuance, it could instead issue a three-year note and simultaneously enter into a swaption.