Mortgage Bonds Rise to `Insane' Highs as Refinancing Drops: Credit Markets
Mortgage securities with U.S.-backed guarantees are trading at record high prices on speculation homeowner refinancing will fail to accelerate and as supply of the bonds remains limited.
The average price of $5.2 trillion of bonds guaranteed by government-supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae climbed to 106.3 cents on the dollar yesterday, according to Bank of America Merrill Lynch’s Mortgage Master Index. That’s up from 104.2 cents on March 31, when the Federal Reserve ended its program purchasing $1.25 trillion of the debt.
“It’s gotten insane,” said Scott Simon, the head of mortgage-backed securities at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s biggest bond fund. “This is rarefied air.”
U.S. existing home sales unexpectedly fell last month and purchases of new houses tumbled to a record low, underscoring how borrowers’ ability to qualify for financing is limited even as rates drop. Bond prices show investors aren’t concerned homeowners will pay back the mortgages underlying the securities at a faster pace, handing them their money back at par and forcing them to reinvest in new debt at lower yields.
Applications for mortgage refinancings are off almost 57 percent from last year’s peak reached in January, according to the Mortgage Bankers Association. The average rate on a typical 30-year home loan fell to a record low of 4.69 percent in the week ended today, down from this year’s high of 5.21 percent in April, McLean, Virginia-based Freddie Mac said today.
Refinancings are being suppressed because more than 23 percent of homeowners with mortgages owe more than their houses are worth, according to Seattle-based Zillow.com. Borrowers also face tougher underwriting standards at lenders selling debt to Fannie Mae and Freddie Mac, said Tad Rivelle, head of fixed- income investments at Los Angeles-based TCW Group Inc., with $115 billion in assets under management.
Elsewhere in credit markets, the extra yield investors demand to hold corporate bonds instead of government debt was unchanged at 194 basis points, or 1.94 percentage point, the Bank of America Merrill Lynch Global Broad Market Corporate Index shows. Yields averaged 4.002 percent.
Indicators of corporate bond risk in the U.S. and Europe rose. The Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or speculate on creditworthiness, climbed 3.65 basis points to a mid-price of 119.15 basis points as of 11:44 a.m. in New York, according to Markit Group Ltd. In London, the Markit iTraxx Europe Index of swaps on 125 companies with investment-grade ratings increased 4.95 to 129.75, Markit prices show.
The indexes typically rise as investor confidence deteriorates and fall as it improves. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Yields on Washington-based Fannie Mae’s current-coupon mortgage bonds backed by 30-year fixed-rate home loans fell to about 3.85 percent yesterday, the lowest since January 2009, before rising to 3.86 percent as of 11:55 a.m. today in New York, according to data compiled by Bloomberg.
Their yields have fallen to within 76 basis points of 10- year Treasuries from this year’s high of 93 basis points on May 24, after climbing from a record low of 59 reached March 29.
Yesterday, Fed officials retained a pledge to keep the benchmark interest rate at a record low for an “extended period” and signaled that Europe’s debt crisis may harm American growth.
The central bank, at a two-day meeting, left the overnight interbank lending rate target unchanged in a range of zero to 0.25 percent, where it’s been since December 2008. High unemployment, low inflation and stable price expectations “are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” the Fed said, repeating language from every policy meeting since March 2009.
Bond buyers view so-called agency mortgage securities as a refuge, said Andrew Harding, who oversees $22 billion as the chief investment officer for taxable fixed-income at PNC Capital Advisors LLC in Cleveland. The government is promising to help Fannie Mae and Freddie Mac honor their guarantees.
“They’ve become an anchor in portfolios,” Harding said. “It’s not Treasuries. It’s got some yield, but it’s not equity- like risk.”
The market for agency mortgage bonds has shrunk since it peaked at $5.4 trillion in February, partly because Fannie Mae and Freddie Mac decided earlier this year to purchase about $200 billion of delinquent loans out of their securities to reduce their expenses, according to Bank of America data.
Many outstanding securities are also no longer trading after the Fed’s unprecedented purchases, which began in January 2009, and the Treasury’s acquisition of an additional $220 billion of the debt in a separate program begun after the U.S. seized Fannie Mae and Freddie Mac in September 2008.
The weak housing market will likely limit future issuance, said David Land, a mortgage-bond manager at St. Paul, Minnesota- based Advantus Capital Management Inc., which oversees about $18 billion. Outstanding U.S. home-mortgage debt has dropped in eight straight quarters since the third quarter of 2008, falling 3.6 percent to $10.2 billion, Fed data show.
New-home sales tumbled 33 percent last month to a record low annual pace of 300,000, the Commerce Department said in a report. Sales of previously owned homes unexpectedly fell 2.2 percent in May, the National Association of Realtors said.
Home Prices Fall
The median U.S. home sales price slid 29 percent to an almost eight-year low of $164,600 in February from a peak of $230,300 in July 2006, according to the National Association of Realtors in Chicago.
Refinancing hasn’t climbed much partly because there are fewer loan brokers competing to earn fees after being blamed for creating more bad loans than direct lenders, Land said.
“There’s less of a solicitation effort going on,” he said. “If anybody were to figure out a way to refinance people, the mortgage-bond market would be in really bad shape.”
Only about 37 percent of 30-year loans are “actually refinanceable” at current mortgage rates, about half of the level suggested by “traditional measures,” Credit Suisse Group AG analysts led by Mahesh Swaminathan wrote in a report. Rates would need to decline to about 4.5 percent for refinangings to begin to jump, the analysts and BNP Paribas’ Anish Lohokare wrote today.
Pimco Cuts Holdings
Pimco’s $228 billion Total Return Fund reduced its holdings of mortgage securities to 16 percent last month, down from 83 percent in January 2009, according to disclosures on its website. Even after ending, the Fed’s purchases are helping fuel an imbalance between supply and demand, Simon said.
The mismatch has contributed to a jump in unsettled mortgage-bond trades, which remain elevated after soaring to the highest on record last month according to Fed data, and a related drop in the cost of borrowing to invest in certain home- loan securities in the so-called dollar roll market.
With dollar rolls, an investor seeking to borrow money enters into contracts to sell mortgage securities one month and then buy similar bonds the next month; a lender would undertake the opposite trades.
The implied cost of such financing for Fannie Mae’s 5.5 percent securities, backed by higher-rate loans than the current-coupon bonds that guide mortgage rates, was about negative 1 percent yesterday, according to Barclays Plc’s estimates. That means debt investors are essentially being paid to borrow rather than paying their lenders.
Prices for some securities have “benefited substantially” from such “roll specialness,” Nicholas Strand, an analyst in New York at Barclays, wrote in a June 18 report. The Fed may “look into helping to facilitate market liquidity” through temporary sales into the roll market, hurting values, he said.