Having shunned U.S. mortgage-related assets for 1-1/2 years, foreign investors are returning to the market now the U.S. government has a key stake.

Overseas demand is mounting given the U.S. Federal Reserve today owns over 20 percent of agency mortgage assets after a 15-month buying spree to lower home loan rates and revive the U.S. housing market.

Added to that, the U.S. Treasury has pledged unlimited credit access to mortgage giants Fannie Mae and Freddie Mac for three years.

Euro zone debt woes have also raised overseas appetite for high-grade U.S. securities.

Renewed foreign investment comes at a critical juncture for more than $7.5 trillion in agency-issued securities after the Fed ended its buying program on March 31 having purchased more than $1.4 trillion in assets.

Foreign investors are really one of the major reasons that there hasn't been a problem since the Fed stepped away, said Scott Wede, managing director and head of pass-through, CMO and ARM trading at Barclays Capital.

U.S. government backing has given new cache to 'AAA' U.S. agency mortgage-related securities that were sold off by overseas accounts during the global financial crisis.

Risk premiums are holding near record lows a month after the Fed sopped up $1.25 trillion in mortgage bonds and almost $175 billion in agency notes. A brief weakening swiftly lured buyers including overseas accounts.

When foreign investors were making purchases two to three years ago, our federal government didn't own any mortgages, said Wede. They may feel like they have partners in this now and they can go back in and buy mortgages.

The markets have proved more resilient than expected once Fed buying ended. Some Wall Street firms have shifted to an overweight recommendation for mortgage bonds.

Chances are slim the Fed would risk raising interest rates and home loan rates by starting outright sales of its mortgage bond holdings soon, most analysts agree.

The Fed's holdings, and the December 2009 decision to open the credit spigot to Fannie and Freddie through 2012 to help stabilize U.S. housing, is reviving confidence.

Thirty-year 4-1/2 percent mortgage bonds yielded around 150-160 basis points more than a blend of 5- and 10-year Treasuries before the Fed buying. The premium got as low as 122 basis points on March 25 before rising to 133 basis points on April 1 after the Fed finished, and still hovers near there.

In addition to U.S. backstops, worries debt problems could spread from Greece to other euro zone economies may have heightened the appeal of high-grade U.S. mortgage-related assets, according to Morgan Stanley.

Rising concerns about sovereign debt in Europe, and widening spreads, may have discouraged central banks from purchasing Euro-denominated debt, Morgan Stanley said in a research note.

CLEARER GOVERNMENT TIES

Government-sponsored-enterprises (GSEs) Fannie and Freddie were taken under government control in September 2008 with housing in freefall and loan defaults eating into the companies' capital.

It's really no longer a question of whether or not the government would step in ... in effect there's really an explicit guarantee on Fannie Mae and Freddie Mac debt, said John Jay, senior analyst at Aite Group in Boston.

Fed data show that foreign central bank ownership of U.S. Treasuries and agency debt has risen for 12 straight weeks.

Overseas central banks held about $789.2 billion of agency-issued debt at the Fed, up $3.6 billion in the latest week and about $20 billion so far this year.

These holdings fell as low as $760.4 billion in November 2009, then treaded water until this recent upturn.

At their peak in July 2008, overseas central banks held $984 billion of agency-related debt before fears about the viability of Fannie and Freddie spurred them to shed $160 billion in the following five months.

This year's growing custody account is concrete evidence that foreign investors are gaining comfort with GSE debt, though it's far from pre-crisis levels, said Nancy Vanden Houten, senior analyst at Stone & McCarthy Research Associates in Princeton, New Jersey.

Treasury made the commitment through the end of 2012 to plug whatever hold needs to be plugged in Fannie and Freddie finances, bolstering overseas demand for debt maturing within three years, Vanden Houten added. The Fed left the mortgage market and the Treasury left the mortgage market as buyers and the world didn't come to an end.

Net overseas GSE debt holdings grew $2 billion in February after a $5 billion outflow in January, Treasury data show. This is relative stability after $27 billion average net monthly sales from July 2008 through January 2009, and net monthly inflows of $10 billion to $30 billion from 2004 to mid-2008.

This year's Fannie and Freddie note deals reveal a heartier appetite emerging, with about 29 percent of new debt placed with foreign central banks, up from about 19 percent in 2009, according to research from Bernard Gordon at Morgan Stanley.

The reentry of foreign central banks is a positive, and could be very supportive for the market, particularly in the front end where the unlimited backstop for the GSEs limits their credit exposure, he said.

(Editing by Andrew Hay)

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