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Mortgage-Bond Spreads Surpass Lows Reached During Federal Reserve Buying
Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates reached record lows relative to 10-year Treasuries as investors search for higher returns amid limited refinancing by borrowers.
Fannie Mae’s current-coupon 30-year fixed-rate mortgage bonds narrowed 0.02 percentage point to about 0.58 percentage point more than 10-year Treasuries as of 1:45 p.m. in New York, according to data compiled by Bloomberg. The gap reached 0.59 percentage point on March 29, two days before the Federal Reserve ended its buying of $1.25 trillion of so-called agency mortgage bonds. The spread matched that low two weeks ago.
Mortgage-bond returns are on pace this month to beat Treasuries’ gains by the most since February 2009, as the U.S. auctions off debt at the lowest yields on record. Debt buyers are focusing on signs that the country’s recovery from the deepest recession since the 1930s is failing to accelerate, rather than better-than-projected corporate earnings.
“It’s been a rip-roaring month for agency mortgages,” said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia. “There’s a huge demand for lower-risk assets in the marketplace. With Treasury yields so low, everybody’s looking for an alternative.”
The average price of the $5.2 trillion of mortgage bonds guaranteed by government-supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae rose to a record of 106.69 cents on the dollar yesterday, from 106.21 cents on June 30, according to Bank of America Merrill Lynch’s Mortgage Master Index.
‘Overseas Demand’
The debt has returned 0.66 percentage point this month more than Treasuries with maturities similar to the securities’ projected average lives, according to Barclays Capital index data.
“Overseas demand has been very, very strong” and “supply hasn’t really hit the table at the pace that people would expect in this interest-rate environment,” Matthew Peterson, a mortgage-bond trader in New York at RBC Capital Markets, said in a telephone interview.
Lenders have been selling about $2 billion to $3 billion of securities into the market a day, he said. While the typical rate on a 30-year loan has been hovering near record lows, refinancing applications declined in the latest week and remain more than 47 percent below their 2009 peak, the Washington-based Mortgage Bankers Association said today.
“The limited response to record low mortgage rates points to a credit pendulum that has swung from overly lenient to overly tight,” Scott Buchta, head of investment strategy at New York-based Braver Stern Securities LLC, said in an e-mail.
Punish Investors
Faster-than-anticipated prepayments on mortgage bonds trading for more than face value punish investors by returning their cash more quickly at par, rather than offering higher coupon payments for a longer period.
Fannie Mae’s 6.5 percent securities, backed by loans with higher rates than current-coupon bonds, climbed to a record 109.94 cents on the dollar yesterday, from 107.22 cents on Dec. 31, Bloomberg data show.
Loans within the securities carry rates of about 7 percent on average, compared with an average rate on new home loans of 4.69 percent, according to data compiled by Bloomberg and the Mortgage Bankers Association.
As Europe’s sovereign debt crisis roiled markets in May, net purchases of agency asset-backed bonds by foreign investors reached $17.3 billion, the most since the Treasury Department began including the figure in monthly reports in March 2009, according to data released July 16.
Volatility Expectations
Prices also have gained as a Barclays index measuring expectations for interest-rate volatility, based on prices for so-called swaptions, fell 19 percent since May 6. That partly reflects investor speculation that the Fed will hold its rate benchmark at a record low for longer amid what Chairman Ben S. Bernanke this month called an “unusually uncertain” outlook.
Greater volatility harms mortgage-bond prices because it makes bigger rises or drops in rates more likely, pushing refinancing and home sales higher or lower. Slower prepayments cause investors to receive their money back slower, typically as higher market yields make their investments less attractive.
Low short-term rates also boost the attractiveness of longer-term debt to the types of investors that use borrowed money to invest, ranging from banks to hedge funds.
“If you think about a low vol environment, you’re going to go for incremental yield,” RBC’s Peterson said.
At the same time, some money managers whose performance is measured against bond indexes are buying agency mortgage debt because they have been holding less than found in the benchmarks on the expectation spreads would widen after the Fed’s buying stopped, he said.
Jumbo Loans
Non-agency mortgage debt, which isn’t found in such indexes, is being boosted by projected yields that “look pretty attractive” and offer good “carry,” such as the 4 percent to 5 percent found with bonds backed by prime-jumbo loans, Jesse Litvak, a Jefferies & Co. trader, said in an e-mail. Alt-A mortgage securities, backed by loans ranked between prime and subprime, may yield 7 percent to 9 percent, he said.
Yields on Fannie Mae’s current-coupon securities have fallen to 3.64 percent from this year’s high of 4.67 percent on April 5, after reaching a record low of 3.51 percent on July 16, Bloomberg data show. Jumbo loans exceed limits for Fannie Mae and Freddie Mac, currently as much as $729,750 in some areas.
After falling to as low as 63 cents on the dollar in March 2009, typical prices for the most-senior securities backed by fixed-rate jumbo loans rose to 86 cents last week, according to Barclays data. That was unchanged from previous week, and 1 cent higher than a month earlier. Similar Alt-A bonds traded at 76 cents, up 1 cent on the week and 2 cents from a month earlier.
To contact the reporters on this story: Jody Shenn in New York at jshenn@bloomberg.net; Mary Childs in New York at mchilds5@bloomberg.net
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