China Mortgage Bond Sales Probably Led Tumble in Foreign Holdings of Debt
A record tumble in the holdings of U.S. agency debt and government-backed mortgage bonds by central banks and similar foreign investors probably reflected sales of home-loan securities by China, according to Wrightson ICAP LLC.
The amount of debt, including notes that fund government- supported mortgage financier Fannie Mae, held by official foreign investors plunged $57 billion in the week ended Sept. 15 to $752.5 billion, according to Federal Reserve data. The category also encompasses mortgage-backed securities, or MBS, backed by loans on U.S. houses and condominiums.
“Our guess is that the steep slide in that week reflects the settlement of forward sales of MBS that had taken place over the course of the previous month,” Lou Crandall, chief economist at Wrightson in Jersey City, New Jersey, said today in a note to clients. Selling began “just after discussions of the possibility of a government-assisted refi wave began to surface this summer.”
The market has never seen such large declines in the foreign investors’ holdings of mortgage bonds guaranteed by government-supported Fannie Mae, Freddie Mac or federal agency Ginnie Mae, even when countries slashed their investments in corporate debt issued by the companies in the months before and after the U.S. seized Fannie Mae and Freddie Mac in 2008, Crandall said in a telephone interview.
Based on weekly averages, the investors’ combined holdings reached a record $984 billion in July 2008, before falling to $760 billion in November 2009, and then expanding back to $831 billion last month, the Fed data show.
China is “far and away the largest foreign investor” in agency mortgage bonds, so would have led the recent sales, Crandall said. The country held $358 billion of the debt as of June 2009. Japan was second, with $96 billion, according to the most-recent Treasury Department data cited by Crandall.
Any seller may have tried to complete its sales before the Fed data could tip the market to its plan, he said.
“It is also possible, however, that this represents an ongoing adjustment that will continue to redirect cash from MBS to the Treasury market in the coming months,” he added.
The Fed’s figures don’t distinguish between holdings of mortgage securities and the corporate debt of government-related companies including Fannie Mae and the Federal Home Loan Bank system.
Calculating the Drop
The difference between the figure reported for Sept. 15 and the average of $796.6 billion reported for the week ended that day shows that most of the decline came on Sept. 14, a so-called settlement date for Class A mortgage-backed securities, Crandall wrote. The holdings dropped again, to $749 billion, on Sept. 22.
Crandall called the most recent decline in overall central bank and sovereign holdings “massive,” though not as much as the Fed reported.
The actual drop was probably less because of the methodology the Fed uses, Crandall said. The calculation is based on the original face amount of the securities and ignores any repayments from refinancing or home sales. Either of those actions would reduce the size of actual holdings.
Two signs the overall decline in holdings by foreign investors was concentrated in mortgage-bond sales rather than sales of the agencies’ corporate debt relate to when the debt matures and the fact that prices for agency corporate debt have been little changed, according to a Sept. 24 report by Barclays Capital analysts Rajiv Setia and James Ma.
The recent tumble probably doesn’t represent permanent change as foreign exchange reserve balances continue to grow, the analysts’ wrote.
“Ultimately in a slower-growth, lower-rate environment, the reach for yield should lead that official demand back into agency debt/MBS -- the latter in particular because valuations have cheapened substantially,” Setia and Ma wrote.
The so-called option-adjusted spread on Fannie Mae’s 30- year current-coupon mortgage bonds, or estimated yield over benchmark swap rates after accounting for prepayment uncertainty, widened from negative 0.13 percentage point since July 30 to positive 0.08 percentage point as of 10 a.m. in New York, according to data compiled by Bloomberg.
The gap widened amid speculation that the government could loosen refinancing rules for borrowers who already have Fannie Mae and Freddie Mac mortgages, creating more lower-coupon securities and causing investors holding higher-coupon bonds to receive their money back more quickly at par.
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