Fannie Mae Mortgage Bonds Decline Most This Year on Refinancing Concerns

Fannie Mae and Freddie Mac mortgage bonds tumbled, with prices for certain debt falling the most relative to Treasuries this year, on concern that refinancing will accelerate after the Federal Reserve said it would buy more government notes to restrain borrowing costs.

Fannie Mae’s 30-year fixed-rate mortgage securities with 4.5 percent coupons declined 0.47 cent on the dollar to 104.28 cents as of 5 p.m. in New York, a drop of 0.39 cent relative to Treasuries, according to data compiled by Bloomberg. The bonds, whose underlying loans’ rates average about 5 percent, reached a record 104.97 cents on Aug. 10.

Mortgage bonds have dropped after climbing to all-time highs on average last month as home-loan rates set new lows in seven of the past eight weeks. Refinancing is accelerating among good-credit borrowers with already low payments, and some investors are concerned that policy makers may change rules to help homeowners blocked by reduced home prices, tighter lending standards and personal financial distress.

Declines in new-mortgage rates seen today in the results of a weekly survey show the borrowers underlying the 4.5 percent bonds moving “firmly into the marginally refinanceable status,” Kevin Cavin, a strategist in Chicago at Sterne Agee & Leach Inc., said today in a note to clients. The homeowners “have extremely high credit quality and are likely to be efficient refinancers.”

The average rate on a typical 30-year mortgage fell to a record low 4.44 percent in the week ended today, down from 4.49 percent last week and this year’s high of 5.21 percent in April, according to McLean, Virginia-based Freddie Mac.

Fed Buying

The 4.5 percent Fannie Mae securities fell 0.02 cent more relative to Treasuries than on March 31, the day the Fed ended a program in which it bought $1.25 trillion of so-called agency mortgage bonds to bolster housing and financial markets, according to Bloomberg data, which is available only through January. The Fed said Aug. 10 that it would buy Treasuries with repayment proceeds from its holdings of the securities and agency corporate debt to help support the economy.

Declines earlier today in Fannie Mae’s 30-year fixed-rate securities with 6 percent coupons, whose underlying loans’ rates average about 6.5 percent, left the bonds underperforming Treasuries by the most over two days since February. The debt later pared the drop, falling 0.19 cent on the dollar to 107.9 cents from yesterday, after earlier declining to 107.75 cents. The bonds reached a record 108.97 cents on July 27.

‘Insane’ Prices

“Nobody who was buying them thought they were cheap,” said Scott Simon, the head of mortgage bonds at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s biggest bond fund, who called prices “insane” in late June. “They were buying because they thought” higher- coupon bonds offered relatively high current payments “and they could get out before they went down.”

Higher-coupon mortgage bonds, whose underlying borrowers tend to have higher-rate loans issued before housing slumped and have most to gain if they can qualify for new debt, have been volatile amid speculation that the government will attempt to stoke refinancing by changing Fannie Mae and Freddie Mac rules.

“Given that the government is taking baby steps here and there” to help homeowners “and the pace of announcements seems to be increasing, people are now budgeting for a non-zero possibility” of a big loosening in refinancing rules, Derek Chen, a mortgage-bond analyst at Barclays Capital in New York, said today in a telephone interview before such debt rallied.

Zero-Interest Loans

Since Aug. 6, the U.S. has announced the details of a plan to encourage lenders to cut principal balances for non- delinquent homeowners owing more than their properties’ values by allowing the borrowers to refinance into government-insured loans, and a program to offer $1 billion of zero-interest loans to help homeowners who’ve lost income avoid foreclosure.

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. Agency home-loan debt is guaranteed by government- supported Fannie Mae and Freddie Mac or U.S. agency Ginnie Mae.

The Fed’s decision this week raised the chances that one of the potential drawbacks to rule changes that would increase refinancing of Fannie Mae and Freddie Mac loans may disappear, Morgan Stanley economist David Greenlaw said. That’s the fact that such refinancing would boost the supply of low-coupon mortgage-backed debt with long-projected lives in the fixed- income market, potentially boosting borrowing costs for everyone from the government and homeowners to corporations.

‘Slam Dunk Stimulus’

The central bank’s announcement shows that if the economy continues to struggle it may be prepared to take “the next step” of increasing the size of its balance sheet through asset purchases, which would offset the increased “duration” reaching the bond market in the form of mortgage securities with new loans, Greenlaw said today in a telephone interview. He fueled speculation over rule changes with a July 27 report calling such a move “slam dunk stimulus.”

“If the Fed were to take additional action in the form of large-scale asset purchases, this type of proposal becomes a very attractive one to pair with that,” he said. “What’s happening in the mortgage market over the last couple of days is I think there’s some recognition of that sort of link.”

Other downsides from such a plan would include the damage to mortgage-bond holders -- including U.S. banks, foreign investors who help finance Treasury sales and Fannie Mae and Freddie Mac themselves -- and that it would reduce Fannie Mae and Freddie Mac’s ability to cut their losses by forcing lenders to repurchase bad loans because of faulty underwriting, according to analysts at Barclays and Nomura Holdings Inc.

‘Political Craziness’

Greenlaw said the biggest hurdle may be the potential for “political craziness,” as the move is “misrepresented” as a bailout for homeowners who made mistakes and something that would add to Fannie Mae and Freddie Mac’s risks.

“It’s clear that the Treasury position is that nothing along these lines is likely in the near-term,” he said, referring to the department’s Aug. 5 response to a Reuters blog report.

Yields on Fannie Mae’s 3.5 percent securities, which may most influence loan rates because they are trading closest to face value and are filled primarily with loans created in recent months, rose today 0.06 percentage point from a record low yesterday to 3.48 percent.

Mortgage securities with the lowest coupons are set to underperform government notes in part because the Fed’s plan to reinvest its holding through Treasury buying “naturally tilts demand to the Treasury side,” Barclays’ Chen said.

Refinancing Policies

Alec Phillips, an economist at New York-based Goldman Sachs Group Inc., wrote today in a note to clients that “it is still conceivable that some incremental changes” could be made to Fannie Mae and Freddie Mac refinancing policies “but we also still think the ultimate effects are likely to be modest if such changes do come to pass.”

While the U.S. announced in February 2009 an initiative called the Home Affordable Refinance Program, it created 291,600 loans through March, compared with a target of 4 million to 5 million, according to data from the Federal Housing Finance Agency. The program is meant to allow more refinancing among borrowers whose loans approach or exceed their properties’ values and who haven’t missed payments, if Fannie Mae and Freddie Mac already own or guarantee their debt.

Hurdles to Refinance

Many borrowers are finding it challenging to refinance, for reasons including: loan values above the 125 percent limit compared to property prices for the program; the need to provide income and asset documentation to meet intermediary loan buyer or Fannie Mae and Freddie Mac rules; and prohibitions blocking certain “underwater” borrowers with mortgage insurance from rolling forward their policies unless they deal with their current servicers, according to lenders such as Quicken Loans Inc. and Equity Now Inc.

Borrowers are also being frustrated because the largest lenders are facing “capacity constraints” and fewer smaller mortgage companies exist after the housing slump, said William Emerson, chief executive officer of Livonia, Michigan-based Quicken.

He said his company, the nation’s 10th-largest home lender according to newsletter Inside Mortgage Finance, continues to close loans in under 30 days and that it would make sense for Fannie Mae and Freddie Mac to ease certain rules.

“At the end of the day, Fannie and Freddie own the risk on these loans over 125 percent, you’d think they’d want to find a solution for these folks,” Emerson said yesterday in a telephone interview.

At the same time, refinancing overall is soaring, and “we are luckily swamped with calls,” even as certain homeowners face such issues, Michael Moskowitz, president of New York-based Equity Now, said in a telephone interview.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

• Tweet
• More
  • Business Exchange
  • Buzz up!
  • Digg
• Print
• Email