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Agency Mortgage-Bond, Debt Spreads Widen After U.S. Downgrade

Yields on the home-loan bonds of the biggest U.S. mortgage companies Fannie Mae and Freddie Mac jumped to the highest relative to U.S. Treasuries in more than two years, after Standard & Poor’s cut the U.S. government’s AAA credit rating and those of the firms.

Fannie Mae’s current-coupon 30-year fixed-rate mortgage-backed securities rose about 0.14 percentage point to 1.22 percentage points more than 10-year U.S. government debt as of 5 p.m. in New York, according to data compiled by Bloomberg. The gap, which ended June at 0.87 percentage point, reached the highest since April 2009.

Treasuries soared today as tumbling stock markets sparked demand for the safety of government debt, sending borrowing costs lower and reversing an initial decline in response to S&P’s decision to cut the U.S. long-term rating. The firm’s grades for Fannie Mae and Freddie Mac, which have been sustained by the government since 2008, are linked to those on America. The companies’ home-loan bonds don’t carry official ratings.

Most of the reason for the wider spreads is “based on uncertainties regarding prepayments and supply, not credit-based downgrade fears,” Walt Schmidt, a mortgage strategist in Chicago at FTN Financial, wrote in a note today to clients.

S&P today lowered the ratings of Fannie Mae and Freddie Mac by one step to AA+ along with the grades of other government-tied issuers including the Federal Home Loan Bank system and the Farm Credit system. The firm also cut bonds guaranteed by the Federal Deposit Insurance Corp. and National Credit Union Association.

Indirect Impact

JPMorgan Chase & Co. analysts led by Matt Jozoff wrote today in a report that they “expect the biggest impact on mortgages to be indirect via higher” interest-rate volatility. This increases investor uncertainty about when the debt will be repaid as projected refinancing by homeowners fluctuates and may increase the cost of borrowing against government-backed mortgage bonds in the repurchase-agreement market if sustained.

The cost of one-month repurchase agreements, or repo, financing for government-backed mortgage securities was unchanged at 0.17 percentage point as of 2:54 p.m., according to data from ICAP Plc, the world’s largest inter-dealer broker. The level reached 0.38 percentage point on Aug. 1 amid concern the U.S. would default, the highest since Dec. 29. The rate has averaged 0.23 percentage point this year.

Yields on the Fannie Mae current-coupon securities, which most affect home-loan rates because they trade the closest to face value, fell today along with Treasury yields. They slumped 0.10 percentage point to 3.54 percent, according to Bloomberg data. On Aug. 4, they reached 3.41 percent, the lowest since November.

Mortgage Rates

Recent drops in mortgage rates to near record lows will boost supply in the mortgage-bond market, by increasing the refinancing of debt held by the Federal Reserve to about $150 billion this year, according to the JPMorgan analysts. That’s $15 billion to $30 billion more than they estimated earlier this year, they wrote in an Aug. 5 report.

The refinancing of loans in securities bought by the Fed typically means that borrowers are taking out new debt that gets placed into bonds trading in the market, boosting what’s available to investors. The Fed now holds about $900 billion of home-loan securities, after purchasing $1.25 trillion through March 2010 in a bid to support the economy.

Spreads on Fannie Mae and Freddie Mac’s unsecured corporate bonds and other so-called agency debt also widened. The gap for Washington-based Fannie Mae’s $3 billion of notes maturing August 2013 widened 0.03 percentage point to 0.18 percentage point, the highest since they were issued in June and up from as low as 0.11 percentage point on July 5, Bloomberg data show.

“The market lately has preferred to sell agencies because their liquidity is inferior to Treasuries,” James Rhodes, a strategist at UBS AG, wrote today in a report.

The U.S. agency mortgage-bond market, which is made up of home-loan securities guaranteed by Fannie Mae, Freddie Mac and federal agency Ginnie Mae, totals about $5.3 trillion. Unsecured U.S. agency debt amounts to about $2.5 trillion, according to the Securities Industry and Financial Markets Association.

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