Mortgage Bonds Lose Ground With Home Refi Boom: Credit Markets

Government-backed U.S. mortgage bonds underperformed Treasuries in August by the most since November 2008 amid concern federal intervention will spark a refinancing wave that reduces the value of the securities.

Fannie Mae, Freddie Mac and Ginnie Mae bonds tied to home loans returned 34 basis points, or 0.34 percentage point, less than U.S. debt last month, Barclays Capital indexes show. Fannie Mae’s 6.5 percent bonds maturing in about 24 years fell 0.75 cent last month to 108.9 cents on the dollar as 4.5 percent Treasury bonds maturing in 2036 gained 8.9 cents to 118.34 cents, according to data compiled by Bloomberg.

President Barack Obama’s administration responded to July’s record decline in U.S. home sales by highlighting the Federal Housing Administration’s refinancing program. Homeowners swapping into new loans, with the lowest mortgage rates in 39 years, would punish bond investors who bought securities pegged to loans with higher interest rates.

“There’s just too many things that could go wrong that could destroy the mortgage market,” said Paul Norris, a senior money manager at Dwight Asset Management Co. “One of them is this government nuclear refi option.”

Norris helps oversee about $15 billion at the Burlington, Vermont-based firm. He joined the company after leaving U.S. mortgage buyer Fannie Mae, where he was director of mortgage portfolios, according to Dwight Asset’s website.

Mortgage Retreat

Government-backed mortgage bonds lost ground even after rallying last week by the most since July 23 relative to Treasuries, Barclays Capital index data shows.

The average rate on a 30-year-fixed U.S. mortgage dropped to 4.36 percent the week ended Aug. 26, the sixth straight decline, according to McLean, Virginia-based mortgage buyer Freddie Mac.

Elsewhere in credit markets, a measure of corporate credit risk in the U.S. fell the most in almost a month after a report showed manufacturing expanded more than forecast. Bonds of NewPage Corp. rose the most in a year and Hexagon AB’s banks started syndicating as much as $2.2 billion of loans.

Credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, dropped 4.8 basis points to a mid-price of 109.7 basis points as of 2:06 p.m. in New York, the biggest decline since Aug. 2, according to index administrator Markit Group Ltd.

Factory Index

The index, which typically falls as investor confidence improves, dropped after the Institute for Supply Management’s factory index rose to 56.3 in August from 55.5 in July, the Tempe, Arizona-based group said today, signaling the industry that led the recovery will keep it from faltering. Economists forecast a decline to 52.8, according to the median estimate in a Bloomberg News survey. Readings greater than 50 signal growth.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings decreased 4.6 basis points to 113.56, and the Markit iTraxx Crossover Index of credit-default swaps on 50 companies with mostly high-yield credit ratings dropped 21.4 basis points to 510.8, Markit prices show.

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A decline signals an improvement in investor perceptions of credit quality. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The decline in the contracts follows global corporate bonds in August returning 2.14 percent, the best monthly gains since July 2009, according to Bank of America Merrill Lynch’s Global Broad Market Corporate index. The debt exceeded the 1.96 percent return for global government debt and a 3.68 percent loss for the MSCI World Index including reinvested dividends.

Extra Yield

The extra yield investors demand to own company debt rather than government bonds widened 4 basis points during the period to 181 basis points, while yields fell to 3.476 percent from 3.751 percent on July 31.

NewPage’s $783 million of 10 percent bonds due in 2012 climbed 7.5 cents to 41 cents on the dollar as of 1:23 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. That’s the most since Sept. 16, 2009, when they gained 8.5 cents.

The Miamisburg, Ohio-based company’s debt, the most traded bonds today, jumped after it forecast fourth-quarter earnings before interest, taxes, depreciation and amortization of between $145 million and $165 million, according to a filing today, which compares with an estimate of $90 million to $100 million for the third quarter. NewPage bonds fell in August after the company posted EBITDA of $10 million in the second quarter, down from $149 million a year earlier.

Hexagon’s Takeover

Hexagon’s lenders are seeking to sell the debt that finances the Stockholm-based surveying equipment maker’s takeover of Intergraph Corp., according to three people with knowledge of the deal.

The borrowings, underwritten by SEB AB and Credit Agricole CIB, include a $900 million five-year term loan for the Intergraph purchase, said the people, who declined to be identified because the matter is private.

In the bond market, Landwirtschaftliche Rentenbank, Germany’s development agency for agribusiness, plans to offer seven-year global notes in U.S. dollars in a benchmark offering as soon as tomorrow, according to a person familiar with the transaction. Benchmark sales are typically at least $500 million.

The debt may yield about 30 basis points more than the benchmark mid-swap rate, said the person, who declined to be identified because terms aren’t set.

Driving Concern

For U.S. mortgage bond investors, refinancings remain a driving concern. Applications to refinance existing home loans climbed to the highest level in more than a year last week, according to the Washington-based Mortgage Bankers Association.

Interested borrowers include homeowners with fixed-rate loans who want to take advantage of falling rates and those with adjustable-rate mortgages who want to lock in a stable monthly cost, said Michael Fratantoni, vice president of research and economics for the Mortgage Bankers Association.

“Treasury rates have come down, and mortgage rates have generally followed,” Fratantoni said in a telephone interview. “In some cases, that’s the upside to an environment where we keep getting economic data which is somewhat weaker than anticipated.”

The 10-year Treasury yield dropped 43 basis points in August, the biggest monthly decrease since December 2008, when the yield fell 71 basis points after the Federal Reserve cut its target lending rate to a range of zero to 0.25 percent.

Maintaining Stimulus

“The other big driver was the government not re-investing mortgage paydowns back into mortgages but investing them into Treasuries,” said John Anzalone, head of mortgage-backed securities at Invesco Ltd., which has more than $557 billion in assets. “That’s almost like the government effectively selling mortgages to buy Treasuries.”

Federal Reserve officials said Aug. 10 that the central bank will reinvest principal payments on its mortgage holdings into long-term Treasury securities as it seeks to bolster the economy by maintaining stimulus.

A widespread government refinancing program is unlikely because it may spur weaker underwriting standards and diminish the value of Fannie Mae and Freddie Mac’s mortgage portfolios, New York-based Citigroup Inc. analyst Brad Henis wrote Aug. 26 in a report.

“What seems to be chief among concerns among participants is some sort of government-engineered refi wave,” Henis said in a telephone interview. “It’s something we think is very unlikely. There’re too many hurdles, both on implementation side as well as side effects of a successful program that are undesirable.”

Banks Retreated

Prepayments on mortgage bonds punish investors by reducing the average interest rate backing securities they purchased.

The $5.2 trillion market for so-called agency securities, which are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, is fueling the bulk of fresh home lending. Banks retreated from the market as they recorded almost $1.8 trillion in losses and writedowns triggered by sour U.S. home loans.

Fannie Mae’s current-coupon 30-year fixed rate mortgage bonds were priced to yield 82.14 basis points more than 10-year Treasuries, data compiled by Bloomberg showed yesterday. That compares with a spread of 54 basis points at the end of July.

“Investors are reluctantly looking for some areas where they can get some incremental yield spread versus Treasuries,” Philip Barach, president of DoubleLine Capital LLC in Los Angeles, said in a telephone interview. “One of those areas would be mortgage-backed securities.”

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