Mortgage-Bond Slump No `Fun' for Housing as Rates Increase: Credit Markets
A slump in government-backed mortgage bonds that’s sent yields to the highest level since May is threatening a recovery in the U.S. housing market, which had been bolstered by record-low borrowing costs.
Yields on Fannie Mae-guaranteed securities that most affect loan rates jumped to 4.22 percent as of 11:28 a.m. in New York, an increase of more than 1 percentage point from an all-time low in October, according to data compiled by Bloomberg.
Higher loan rates “won’t be fun” for a fragile housing market, said Scott Simon, head of mortgage bonds at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s biggest bond fund. “If you were looking at buying a house a few weeks ago, the same house, to you, looks as much as 9 percent more expensive,” he said.
Investors in agency mortgage securities have suffered during this month’s crash in bond prices amid speculation that President Barack Obama’s agreement to extend and expand tax cuts will bolster growth and inflation. While the drop hasn’t been as severe as for Treasuries, the effects of higher mortgage rates, along with climbing gasoline prices, will offset much of the tax package’s intended stimulative effects, according to Gluskin Sheff & Associates Chief Economist David Rosenberg.
Monthly Payments Climb
The average rate on a typical 30-year fixed-rate mortgage has climbed for four weeks, to an average of 4.61 percent last week, according to Freddie Mac, pushing the monthly cost of a $300,000 loan to $1,540, from $1,462. The rate had dropped to a record low 4.17 percent in the week ended Nov. 11 amid speculation that a bond purchasing program by the Federal Reserve would restrain yields.
Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar-maturity government debt was unchanged at 171 basis points, or 1.71 percentage points, down from this year’s high of 201 basis points in June, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 3.952 percent.
The cost of protecting bonds from default in the U.S. fell for a 10th straight day, the longest streak since October 2006. The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, fell 0.41 basis point to a mid- price of 86 basis points as of 11:27 a.m. in New York, according to index administrator Markit Group Ltd.
The credit swaps index, which typically falls as investor confidence improves and rises as it deteriorates, has dropped from 99.4 at the end of November. The index last fell for 10 straight trading days in the period ended Oct. 26, 2006, Markit data show.
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.
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 $5.3 trillion market includes debt guaranteed by government-supported Fannie Mae and Freddie Mac and federal agency Ginnie Mae.
The difference between yields on Fannie Mae’s current- coupon securities, which most influence loan rates because they trade closest to face value, and 10-year Treasuries has narrowed to 84.3 basis points, from a 15-month high of 99 basis points on Dec. 1, Bloomberg data show.
A widening of spreads before the rise in yields and an outlook for lower bond issuance as fewer homeowners refinance have helped agency mortgage bonds outperform the Treasury market this month, said Tom Sontag, a portfolio manager in Chicago at Neuberger Berman Group LLC.
“They had gotten more attractive from a spread standpoint: That drew investors into them, which prevented their prices from falling further,” said Sontag, whose firm oversees about $16 billion in structured-product investments.
Housing demand has slumped this year as tax credits for buyers expired and unemployment hovered below 10 percent. Sales of existing homes, which reached a record low in July, rose to an annual pace of 4.43 million in October, compared with a yearly average of 5.81 million in the past decade, the National Association of Realtors said Nov. 23.
About 10.8 million homes, or 22.5 percent of those with mortgages, were worth less than the debt owed on them as of Sept. 30, according to CoreLogic Inc. An additional 2.4 million had less than 5 percent equity, the Santa Ana, California-based real-estate information company said Dec. 12.
As many as 8 million homes are in some stage of default or foreclosure, known as shadow inventory, and may be offered for sale over the next five years, according to Morgan Stanley.
“The run-up in mortgage rates will not be suppressing demand at a time when the market is close to being in balance, but when there is still gargantuan excess supply,” Rosenberg said in a telephone interview. He cited an S&P/Case-Shiller home-price index showing a 1.5 percent decline in the three months ended in September.
Agency mortgage securities returned 37 basis points more than similar-duration Treasuries this month through Dec. 10, losing 98 basis points on an absolute basis, according to Barclays Capital index data.
“It’s definitely been a meaningful move in yields and clearly that move has had a direct impact on mortgage rates,” said Matthew Marra, a fixed-income portfolio manager at New York-based BlackRock Inc., the world’s largest asset manager.
The increase also exacerbated a selloff in Treasuries, as mortgage investors and servicers shed debt with the projected lives of their securities roughly doubling on average because of lower forecasts for homeowner refinancing, he said.
The increased affordability of homes in light of lower home prices means that the recent rise in mortgage rates will have little effect on the value of bonds in the non-agency mortgage market, said Neuberger’s Sontag, who has been buying subprime- mortgage securities.
“They’re still pretty low rates,” said Didi Weinblatt, vice president of mutual fund portfolios at USAA Investment Management in San Antonio, where she helps oversee about $45 billion.
Non-agency home-loan bonds have joined high-yield company debt this month in avoiding losses thanks to their higher projected yields. High-yield bonds have returned 0.95 percent this month, Bank of America Merrill Lynch index data show.
Typical prices for the most-senior securities backed by option adjustable-rate mortgages rose to 53.95 cents on the dollar, from 52.60 cents on Nov. 30 and 48.21 cents on Dec. 31, according to JPMorgan Chase & Co. data. Option ARMs allow borrowers to pay less than the interest they owe each month, adding the unpaid amount to the overall mortgage balance.
“If rates go up another 100 basis point will that have an impact? Yes. Do I think that’s going to happen in the near-term? No,” Sontag said. “To not think that the 10-year Treasury around these levels is at fair value, you have to buy into the theory that inflation genie is out of the bottle.”
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