Soft Freddie Mac 5-Year Auction Shows Credit Worries

U.S. government-backed mortgage finance company Freddie Mac caused ripples through the debt market on Tuesday after weak results in a $3 billion, 5-year note auction.

The reference note sold for 113.0 basis points above the 5-year Treasury benchmark. Before the auction, the 5-year spread was 105 bps.

On Monday, shares of Freddie Mac were under assault, falling 25% after Barron's magazine reported a growing likelihood the U.S. government will have to bail out the government-sponsored agencies because of an inability to raise capital.

Last week, the 5-year Treasury-Agency spread was at 96 basis points. Analysts say there's no reason to question the implicit government guarantee carried by senior Freddie Mac debt.

"I don't think it is a question at all," said Kevin Giddis, head of fixed income at Morgan Keegan. "I think it will extend into subordinated debt as well."

Prior to the official announcement of the auction results, Treasuries rallied on rumours, which proved correct, of the +113 spread. Futures on the 10-year U.S. note jumped 7 ticks to 116-20.

Settlement for the issue is on Wednesday and it matures on Sept. 27, 2013. Market watchers were eagerly anticipating demand figures, especially from overseas.

Reuters reported that 58% of the issue was sold to investors in North America, 31% to Asia and 10% to Europe.

Freddie Mac has raised 14.4 billion in new capital since December to offset credit losses.

The coupon on the notes is 4.125% and was issued at 99.781, making the yield 4.172%. It was the highest yield over the benchmark for an agency auction in at least 10 years. In February, however, the Treasury-Agency spread reached a high of +116 bps.

As of 10:50 a.m. EDT, shares of Freddie are down 6.4% and Fannie 4.4%. It's unclear if U.S. Treasury officials will take over the GSEs before the stocks fall to zero.

"If you look at the housing act itself, it does allow the Treasury to buy the stock. The hope is that Fannie and Freddie figure this out without government support," Giddis said.

By Adam Button and edited by Sarah Sussman