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Mortgage-Bond Yields That Guide Lending Soar by Most Since 2010

Fannie Mae headquarters stands in Washington, D.C. Photographer: Andrew Harrer/Bloomberg
Fannie Mae headquarters stands in Washington, D.C. Photographer: Andrew Harrer/Bloomberg

March 14 (Bloomberg) -- Yields on Fannie Mae and Freddie Mac mortgage bonds that guide U.S. home-loan rates soared in the biggest two-day jump in 15 months as borrowing costs rise from almost record lows.

Fannie Mae’s current-coupon 30-year securities climbed 0.15 percentage point to 3.16 percent as of 5 p.m. in New York, the highest level since Nov. 14, after an increase of 0.12 percentage point yesterday, according to data compiled by Bloomberg. The two-day rise, after the Federal Reserve’s better assessment of the economy, was the largest since December 2010.

Mortgage-bond yields rose faster than those of benchmark Treasuries as the Fed’s statement signaled a reduced likelihood of a third round of so-called quantitative easing and higher odds the central bank will raise its benchmark for short-term rates earlier than expected. Prices for the home-loan securities fell more than government notes on diminished speculation that the Fed will buy more housing-related debt and as rising rates extend the notes’ duration.

The two issues worked “together as a tag-team to knock down mortgages,” said Tae Park, a money manager in New York who oversees mortgage-bond investments at Societe Generale SA.

Government-backed mortgage securities with lower coupons extended losses relative to Treasuries after the failure of yields to retreat following a $13 billion auction of 30-year government bonds, according to Ajay Rajadhyaksha, head of global rates and securitized strategy at Barclays Capital. That raised concern this week’s sell-off may not reverse, he said.

Low-Paying Debt

“You could have a situation where you’re stuck” with the low-paying mortgage debt for 15 years, as refinancing among the underlying homeowners with low-rate loans becomes unlikely, Rajadhyaksha said today in a telephone interview.

Fannie Mae’s 3 percent, 30-year securities fell 0.23 cent on the dollar more than similar-duration Treasuries, following underperformance of 0.09 cent yesterday, Bloomberg data show. The difference between yields on a Bloomberg index for Fannie Mae current-coupon bonds and 10-year Treasuries rose to 0.89 percentage point, from 0.85 percentage point on March 12. The measure includes the 3 percent securities and reflects debt that most influences rates because it trades closest to face value.

“In a move like this, mortgages are supposed to underperform,” Dave Cannon, co-head of mortgage-bond trading at RBS Securities Inc. in Stamford, Connecticut, said in a telephone interview.

Prompts to Sell

As rates increase, the projected lives of mortgage bonds and loan-servicing contracts extend, partly because potential refinancing by homeowners declines. Investors and servicers then have portfolios with longer-than-expected durations, which may prompt them to sell mortgage bonds, longer-dated Treasuries or interest-rate swaps. Those sales can send yields higher.

Yields may need to increase by an additional 0.20 to 0.25 percentage point “to kick off significant MBS extension flows,” Anish Lohokare, an analyst at BNP Paribas SA, wrote in a note to clients.

The average rate on a typical 30-year fixed-rate mortgage was 3.88 percent last week, or 0.01 percentage point higher than the record low last month, according to Freddie Mac surveys. Borrowing costs last year reached as high as 5.05 percent in February 2011.

$5.4 Trillion Market

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 $5.4 trillion market includes securities guaranteed by government-supported Fannie Mae and Freddie Mac and bonds of federally insured loans guaranteed by U.S.-owned Ginnie Mae.

Borrowing costs may not rise as much as bond yields because lenders might seek to maintain the volume of their business in a mortgage refinancing boom and allow profit margins to drop.

“Originators will look to keep rates low and keep their pipelines full so long as they can do it economically,” Scott Buchta, head of mortgage strategy in Chicago at Sandler O’Neill & Partners LP, said in an e-mail.

The difference between the yields on Fannie Mae’s current-coupon securities and rates on 30-year loans fell last week to about 1 percentage point from more than 1.5 percentage points in February, compared with an average of about 0.6 percentage point over the last decade, according to data compiled by Bloomberg.

While the Fed has sought to lower rates to bolster a struggling property market and help the economy recover, rising borrowing costs may spur potential homeowners to buy on concern that they will move higher, First Pacific Advisors LLC’s Julian Mann said.

Those individuals, who have been facing rising rents as home prices decline, “may say, ‘that’s it, I’m not going to wait any longer,’” Mann said in a telephone interview. He helps oversee $5.7 billion in bonds as a vice president at Los Angeles-based First Pacific.

To contact the reporter 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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