Mortgage Bond Prices Show Refinancing Limits: Credit Markets

The mortgage-bond market is signaling changes to refinancing rules will aid fewer homeowners who owe more than their properties’ value than was initially anticipated.

Fannie Mae’s 30-year, 5.5 percent securities have risen to the highest since Oct. 3, erasing a decline later in the month sparked by a plan to expand the Home Affordable Refinance Program. Bondholders can be hurt by refinancing because prepayments curb the interest they receive.

Investors are downplaying the effects of adjustments to Fannie Mae and Freddie Mac refinancing rules for so-called underwater homeowners after strategists speculated that the revisions will provide lenders less protection than expected. At the same time, rising interest rates on new home loans may drive banks to focus on qualifying homeowners with the highest-cost debt as fewer of the safest borrowers seek to lower their monthly payments.

“There will be more lender resources devoted to HARP as the regular refi business takes a back seat,” said Walt Schmidt, a mortgage strategist in Chicago at FTN Financial, the brokerage unit of First Horizon National Corp. “You’ve got a fulcrum right around the 4.5 percent rate where the focus is going to shift between the normal refis or HARP, because that’ll be all that’s left to do.”

Fannie Mae

About 894,000 loans have been refinanced under HARP, according to the Federal Housing Finance Agency, the independent regulator of Fannie Mae and Freddie Mac that says the volume may double by the end of 2013. President Barack Obama said the program would aid 4 million to 5 million homeowners as the initiative for non-delinquent borrowers was introduced in 2009.

Debt in the $5.4 trillion market for agency mortgage securities guaranteed by Fannie Mae, Freddie Mac or government-owned Ginnie Mae outperformed U.S. Treasuries by 44 basis points in October through last week, the most since December, according to Barclays Capital index data. The housing debt trailed U.S. government notes during each of the previous three months.

Elsewhere in credit markets, the cost of protecting corporate bonds from default in the U.S. rose for a third day. The Markit CDX North America Investment Grade Index, a credit-default swaps index that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, climbed 8.5 basis points to a mid-price of 129.3 basis points as of 12:03 p.m. in New York, according to Markit Group Ltd. The index has climbed from 113.4 on Oct. 27, which was the lowest level since Aug. 17.

Rate Swaps Climb

The index typically rises as investor confidence deteriorates and falls as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Interest-rate swaps, a measure of stress in credit markets, also rose. The difference between the two-year swap rate and the comparable-maturity Treasury note yield gained 2.4 basis points to 34.9 basis points, according to data compiled by Bloomberg. The measure, which gains when investors favor government bonds, jumped from 33.25 at the end of September and reached 39 on Oct. 7, the highest since June 2010.

A Bloomberg index for yields on Fannie Mae’s 30-year current-coupon securities, which new mortgages get packaged into because they trade closest to face value, has risen to 3.04 percent from an all-time low 2.78 percent on Sept. 22, as progress in Europe on the region’s debt crisis lessened demand for benchmark Treasuries and drove up borrowing costs.

Refinancing Damages

Fannie Mae’s 5.5 percent bonds have risen to 108.59 cents, from a six-month low of 107.78 cents on Oct. 24, Bloomberg data show. Rates on the underlying loans average about 6 percent, compared with new loan rates of 4.20 percent and a record low 4 percent on Sept. 22, data show.

Refinancing damages investors in mortgage bonds trading for more than face value by repaying them faster at par and reducing future interest, a risk that pushed Norway’s $570 billion sovereign wealth fund to dump all its holdings of Fannie Mae and Freddie Mac securities last quarter.

With homeowners’ ability to qualify for refinancing hindered by tightened lending standards and the worst slump in property prices since the 1930s, almost $1 trillion of 30-year Fannie Mae and Freddie Mac securities with coupons of 5.5 percent or more remain outstanding, Bloomberg data show.

Las Vegas Appearance

Obama and Federal Reserve Chairman Ben S. Bernanke have urged adjustments to the companies’ HARP programs to bolster housing and the economy by aiding consumers stuck with high-cost mortgages.

Lenders’ focus on HARP loans declined in recent months as traditional refinancing soared with rates near record lows, according to PHH Corp. Chief Executive Officer Jerome Selitto, whose Mount Laurel, New Jersey-based company is the sixth-largest U.S. home lender.

“If we see an abatement in other refi activity, you’ll see an increase in participation in the HARP program,” he said in a Oct. 10 interview at an industry conference, before the planned adjustments were announced.

Obama discussed the changes on Oct. 24 in remarks outside a home in Las Vegas. Nevada has the highest foreclosure rate in the U.S. The FHFA offered an outline of the expansion earlier that day, sparking a slump in mortgage bonds and causing Fannie Mae’s 6 percent debt to underperform Treasuries by the most in 20 months.

‘More Interpretations’

Four days later, Nomura Securities International Inc. analysts wrote a note to clients on the reaction among high-coupon securities, titled “HARP Changes: What HARP Changes?”

“As you saw more and more interpretations of what the details would be, you had more investors that thought, ‘This won’t have as much of an impact as initially the headlines would have led you to believe,’” said Bill Bemis, a senior fixed-income money manager at Aviva Investors in Des Moines, Iowa.

Bemis, whose firm oversees more than $60 billion of assets in the U.S., still anticipates the effects will be greater than he expected before the FHFA’s announcement. A pledged loosening to lenders’ contractual promises to repurchase loans after underwriting mistakes was the biggest surprise, he said.

Those latter adjustments may involve only a matching of procedures at Fannie Mae and Freddie Mac and it’s uncertain what an exception for fraud will cover, according to analysts at Credit Suisse Group, Nomura and Barclays Capital.


Fannie Mae now more often requires promises about the current value of properties. Freddie Mac eliminates fewer representations about the underwriting of the original loans.

Some further details on the planned changes were provided in “information sessions” conducted by Fannie Mae, Freddie Mac and the FHFA, Credit Suisse said in an Oct. 26 report. Full guidelines will be released by Nov. 15 and some lenders may start taking applications by year-end, according to the FHFA.

A “harmonization” of Fannie Mae and Freddie Mac mortgage-repurchase policies and “better communication to lenders” are among the biggest tweaks to HARP, potentially allowing an additional 720,000 borrowers to refinance by the end of 2013, the Credit Suisse analysts led Mahesh Swaminathan wrote.

Fannie Mae and Freddie Mac also will remove rules that cap how underwater borrowers can be, and reduce or eliminate certain upfront fees for weaker credits, the FHFA said. The firms will also nix appraisals in more instances and require on-time payments only over the prior six months, rather than as long as one year.

Refinancing Challenges

Annual interest savings probably will between $2.5 billion and $3.5 billion, according to Credit Suisse. Mark Zandi, chief economist at Moody’s Analytics in West Chester, Pennsylvania, told a Senate panel on Sept. 14 that a broad program for government-backed loans could produce $50 billion a year.

Prepayment speeds for 5.5 percent bonds from 2006 through 2008 will probably increase by a pace that erases about 11 percent or 12 percent more of the debt in a year as result of the tweaks, the Nomura analysts estimated in an Oct. 28 report.

Asked during his Oct. 4 testimony to Congress’s Joint Economic Committee what lawmakers should consider to help housing, Bernanke suggested they “look carefully” at refinancing challenges.

“There are a lot of barriers to refinancing, including the fact that people who are underwater have a great deal of difficulty refinancing,” Bernanke said.

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