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Mortgage Bonds Wrongly Predict Refi Changes, Credit Suisse Says

Prices in the market for Fannie Mae and Freddie Mac mortgage bonds are incorrectly forecasting a 55 percent chance of a “government-induced refi spike” in the next year, according to Credit Suisse Group AG.

Government-backed mortgage bonds are underperforming U.S. Treasuries this month by the most since 2008, in part because of concern that the U.S. may change refinancing rules for Fannie Mae and Freddie Mac mortgages as issues including reduced home prices prevent borrowers who have been paying on time from taking out new loans at record-low interest rates.

The extent of investor speculation about a refinancing program that would be “neither practical nor costless” can be seen in the weaker performance of mortgage bonds backed by higher-cost loans in comparison to those with lower-rate mortgages, as well as differences in prices of contracts to buy the debt in different months, the Credit Suisse analysts led by Mahesh Swaminathan wrote today in a report.

The odds for a “government-induced refi spike” implied by current prices are “unrealistic,” Swaminathan said in a telephone interview. That’s in part because of a Treasury Department statement this month denying a report that the U.S. is considering expanding the federal Home Affordable Refinance Program including by reducing some loans’ balances, he said.

“If there were any plans to do something, there wouldn’t be this quick denial,” Swaminathan said.

Better Returns

Prices of Fannie Mae-guaranteed 5.5 percent 30-year fixed-rate mortgage securities have fallen to 0.78 cent on the dollar more than the Washington-based company’s 5 percent bonds as of 11 a.m. in New York, according to data compiled by Bloomberg. Today’s gap, which is down from 1.53 cent on July 27, matches the lowest since May 2009. Investors should bet the 5.5 percent debt will offer better returns, according to the New York-based Credit Suisse analysts.

The former bonds contain loans with average rates of about 6 percent, compared with about 5.5 percent in the latter debt. They’re dropping on a relative basis amid concern that qualification standards may loosen to enable underlying borrowers with a greater incentive to refinance, and more credit challenges, to do so.

The average rate on a typical 30-year mortgage fell to a record low of 4.36 percent this week, according to McLean, Virginia-based Freddie Mac.

The $5.2 trillion of agency mortgage bonds guaranteed by government-supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae has returned 0.40 percentage point this month through yesterday less than Treasuries with maturities similar to the securities’ projected average lives, Barclays Capital index data show.

That’s the worst relative performance since November 2008, when the securities underperformed U.S. debt by 0.68 percentage point amid the depths of the global financial crisis sparked by other U.S. housing debt. Last month, the bonds returned 0.44 percentage point more than Treasuries.

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