Mortgage-Bond Yields Tumble, Signaling Loan Rates Nearing Record

Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates fell to the lowest in almost nine months, signaling borrowing costs to purchase and refinance houses may reach new lows.

Fannie Mae’s current-coupon 30-year fixed-rate bonds dropped 0.18 percentage point to 3.45 percent as of 3:05 p.m. in New York, according to data compiled by Bloomberg. Yields tumbled to the lowest level since Nov. 10, generally tracking drops in Treasuries, as concern the economy is slowing and Europe’s fiscal crisis will spread drove investors to U.S. debt.

The average rate on a typical 30-year home loan slumped to 4.39 percent in the week ended today, nearing the record low of 4.17 percent set in November, according to a Freddie Mac survey compiled before the additional gains in the bonds. Falling rates should in the short term help depress yields relative to Treasuries on agency mortgage securities trading the closest to face value, even though they may create wider spreads over time, according to Nomura Securities International Inc. analysts.

The mortgage bonds’ relative performance over the longer term may be “weak because of paydowns from the Fed’s portfolio, but there are several short-term positive factors that exist,” the New York-based analysts led by Ohmsatya Ravi wrote yesterday in a note, referring to the home-loan securities bought by the Federal Reserve in 2009 and 2010 to support the economy.

Home Lending

Yields on agency mortgage bonds are now guiding rates on almost all new U.S. home lending following the collapse of the non-agency market in 2007 and a retreat by banks. The $5.3 trillion market includes securities guaranteed by government- supported Fannie Mae and Freddie Mac and the bonds of government-insured loans backed by federal agency Ginnie Mae.

Lower borrowing costs have done little to boost home sales as banks keep lending standards tight, the unemployment rate sticks above 9 percent and a glut of foreclosed properties drag down prices. Sales of previously owned homes declined in June to a seven-month low, the National Association of Realtors said last month. Home values in 20 U.S. cities dropped 4.5 percent in the year ended in May, according to the S&P/Case-Shiller index.

About 22.7 percent of homeowners with mortgages were underwater in the first quarter, meaning they owe more than their properties are worth, according to CoreLogic Inc., a company that compiles mortgage market data and analytics.

Refinancing Applications

Depressed home prices and tougher standards have left refinancing applications 45 percent below last year’s high and 72 percent off 2003’s record, according to Mortgage Bankers Association data released yesterday. Further drops in rates may stoke refinancing further by pushing new loan costs below the levels in effect as borrowers qualified under stricter guidelines in recent years. Refinance applications have climbed about 50 percent from this year’s low in February.

Limited application volumes also mean that lender competition isn’t easing as interest rates drop, a difference from last year, when mortgage companies raised the rates they offer to consumers relative to bond yields to suppress demand for their services and keep their workloads manageable.

“This means that lower 10-year rates are translating into lower mortgage rates in this rally faster than last time around,” Bank of America Corp. analysts Chris Flanagan and Vipul Jain wrote today in a report. “Therefore, we will most likely reach record lows in 30-year mortgage rates that we saw last year at a higher level” of 10-year Treasury yields.

‘Underhedged’

Items that may help yields on mortgage bonds narrow relative to Treasuries in the short term include loan servicers being “underhedged” as the projected lives of their contracts shorten and needing to add debt, and the increasing appeal of “carry trades” to banks and real estate investment trusts amid speculation the Fed will hold its target for short-term borrowing costs at as low as zero for longer, according to the Nomura analysts.

Carry trades involve using money borrowed in short-term markets to invest in longer-term, higher yielding debt.

The difference between yields on the Fannie Mae current- coupon securities, which most influence loan rates because they trade closest to par, and 10-year Treasuries narrowed about 0.02 percentage point today to 0.98 percentage point, Bloomberg data show.

The spread climbed to a two-year high of 1.04 percentage point two day ago, amid concern that a default by or downgrade of the U.S. government could roil the repurchase-agreement financing markets used by mortgage-bond investors or lead to forced sales of securities.

Projected Lives

As rates decline, the projected lives of mortgage bonds and loan-servicing contracts fall, partly because potential homeowner refinancing increases. Servicers and investors who own the securities then have portfolios with shorter-than-expected durations, which may prompt them to buy longer-dated Treasuries, mortgage bonds or interest-rate swaps. Those purchases may send yields on mortgage securities even lower.

As refinancing increases, the repayment of loans in securities held by the Fed also rises, with borrowers taking out new debt that gets placed into bonds trading in the market, boosting the supply available to investors. The Fed now holds about $900 billion of home-loan securities, after buying $1.25 trillion through March 2010 in a bid to support the economy.

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

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net

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