Mortgage-Bond Sales Soar on Fed’s Refinance Push: Credit Markets
Sales of U.S.-backed mortgage bonds soared to a three-year high as steps by the Federal Reserve and Obama administration to make home ownership more affordable propelled a 34 percent jump in refinancing.
Issuance of securities guaranteed by government-supported Fannie Mae and Freddie Mac or U.S.-owned Ginnie Mae has climbed to $1.72 trillion, compared with $1.22 trillion last year and $1.73 trillion in 2009, according to data compiled by Bloomberg. With weekly rates on 30-year home loans falling to record lows eight times since July, the first increase since 2009 in refinancing has driven total lending to almost $1.8 trillion this year, double a forecast from the Mortgage Bankers Association in October 2011.
The Fed, the biggest buyer in the $5.2 trillion market, has purchased about $500 billion of the debt in 2012 as it tries to stoke the economy while President Barack Obama promotes programs to help more homeowners lower their monthly bills. In September, the central bank accelerated purchases of mortgage securities by $40 billion a month for its third round of so-called quantitative easing, or QE3.
“The supply over the last three months in particular has been stronger than we anticipated, even given QE3,” Walt Schmidt, a mortgage strategist in Chicago at FTN Financial, said in a telephone interview. The gains partly reflected originators increasing capacity through hiring, he said.
While issuance of home-loan bonds without U.S. backing also climbed, sales are below the peaks reached before delinquencies on the loans helped spark the worst financial crisis since the Great Depression. Sales tied to new home loans quintupled to $3.5 billion, compared with the record annual pace of $1.2 trillion reached in 2005 and 2006, Bloomberg-compiled data show.
As in the past three years, “the agency mortgage market was the only game in town for new origination,” Royal Bank of Scotland Group Plc strategists Jeana Curro and Ashley Gam wrote in a 2013 outlook published Dec. 13.
Next year, agency mortgage-bond issuance may slip to $1.65 billion as refinancing remains elevated and higher Fannie Mae and Freddie Mac insurance fees help push banks to retain more home loans, they said.
Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. rose for a fourth day. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, added 1.6 basis points to a mid-price of 96.7 basis points as of 11:45 a.m. in New York, according to prices compiled by Bloomberg.
The measure, which has climbed from a three-month low on Dec. 20, typically rises as investor confidence deteriorates and falls as it improves. Credit-default 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.
The U.S. two-year interest-rate swap spread, a measure of debt-market stress, was little changed at 14.4 basis points as of 11:44 a.m. in New York. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures.
Bonds of Caracas-based Petroleos de Venezuela SA, or PDVSA, are the most actively traded dollar-denominated corporate securities by dealers today, with 33 trades of $1 million or more as of 11:46 a.m. in New York, according to Trace, the bond- price reporting system of the Financial Industry Regulatory Authority.
U.S. government-backed mortgage bonds have returned 2.5 percent this year through yesterday, beating similar-duration Treasuries by 1.3 percentage points, Bank of America Merrill Lynch index data show. In 2011, the home-loan debt gained 6.1 percent, underperforming the government notes by 0.8 percent.
Higher refinancing that lowers mortgage-bond returns by curbing interest limited the gains even as the Fed’s buying sent prices to records. Investment-grade corporate bonds in the U.S. returned 10.1 percent.
Non-agency securities backed by subprime mortgages issued before the housing market collapsed in 2007 beat most fixed- income assets, with returns averaging 40.5 percent, Barclays Plc index data show. After losing 5.5 percent last year, the debt rallied as home-prices climbed and a calming of Europe’s debt crisis and the Fed’s actions drove investors toward riskier debt.
Home-loan originations may rise 21.6 percent in 2012 to $1.75 trillion, the highest since 2009, as refinancing reaches $1.25 trillion, according to the Mortgage Bankers Association. Refinancing fell 25 percent last year. Volumes, which peaked at $3.8 trillion in 2003, may drop to $1.41 trillion next year, with $818 billion of refinances, the Washington-based group forecast this month.
At its annual conference in October 2011, Jay Brinkmann, the group’s chief economist, said lending would probably decline 25 percent this year to $900 billion. The association had predicted declines in refinancing activity for three years because of its forecasts of rising interest rates, he said. Instead, the average rate was at a then-record low.
“One of these years, I guess we’ll get it right,” Brinkmann said at the time. “It’s really difficult to forecast interest rates in this environment” because of the Fed’s involvement in the debt market.
In a Dec. 19 commentary, Brinkmann’s group said a drop in lending next year will be led by a decline in refinancing, with rates on typical 30-year, fixed-rate mortgages rising to more than 4 percent.
Many borrowers have already locked in loans at lower rates. The average 30-year rate fell as low as 3.31 percent in November, from 3.95 percent at the end of 2011, according to Freddie Mac surveys. The rate was 3.37 percent in the week ended Dec. 20.
The Obama administration fueled additional opportunities for refinancing by pushing Fannie Mae and Freddie Mac at the end of 2011 to expand the Home Affordable Refinance Program, or HARP, for borrowers with little or no home equity.
Almost 791,000 loans were refinanced under HARP in the first 10 months of 2012, compared with 400,000 in 2011, according to a report by the Federal Housing Finance Agency. The Federal Housing Administration began allowing homeowners replacing older loans to avoid insurance-cost increases.
While HARP’s use should begin to taper off by April or May, further “tweaks” are also possible, Nomura Securities International analysts led by Ohmsatya Ravi wrote in a Dec. 6 report, predicting gross issuance of $1.65 trillion to $1.7 trillion next year.
Lenders were overwhelmed by demand this year, frustrating the Fed and pushing the gap between loan rates and mortgage-bond yields higher, with the so-called primary-secondary spread reaching a record 1.8 percentage points in September, Bloomberg data show. The difference declined to 1.1 percentage point as of last week as applications fell and originators added staff.
The narrowing reflects most originators “taking the slow and steady approach to capacity as a sharp rise in rates poses a big risk,” said Scott Buchta, head of fixed-income strategy at Brean Capital LLC. The fact that the gap is still elevated means that borrowing costs probably have room to rise more slowly than yields on mortgage securities if bond rates climb, as lenders seek to maintain their volumes, he said.
In the first 10 months of this year, mortgage lending employment rose by 8.5 percent, Morgan Stanley analysts Vipul and Janaki Rao wrote in a Dec. 7 report, citing Bureau of Labor Statistics data. The growth, which largely started in May, compared with a 0.9 percent gain in the broader “financial activity” category of workers, they said.
The analysts forecast gross issuance of $1.58 trillion next year, as banks restrain the total by retaining new loans to increase their interest income, and net issuance of about $33 billion. Gross issuance will probably total $1.67 trillion this year and $1.75 trillion next year assuming interest rates don’t change, according to Bank of America analysts.
Bank of America analysts led by Satish Mansukhani and Chris Flanagan forecast issuance in a range of $1.47 trillion to $2.06 trillion, the highest since 2003, depending on whether borrowing costs rise or fall by 50 basis points.
The Nomura analysts say issuance will likely decline to $1.25 trillion to $1.35 trillion if rates back up to 4 percent.
Next year, sales of non-agency securities may rise to $20 billion to $30 billion, according to JPMorgan analysts, while Bank of America sees $30 billion and Barclays forecasts a climb to less than $20 billion. Private investors may be called on even more as Fannie Mae and Freddie Mac are pushed to create separate securities that transfer some of their default risks.
Banks present a drag on potential mortgage bonds after the gap between their deposits and loans this month exceeded $2 trillion for the first time.
Wells Fargo & Co. said it retained $9.8 billion of mortgages eligible to be packaged into government-backed bonds last quarter to boost its interest income as the Fed’s buying makes investment in the securities less attractive. Closed-end residential loans held by commercial banks rose to $1.58 trillion as of Dec. 12, from about $1.53 trillion at the start of the year, Fed data show.
An “impediment for banks to securitize whole loans is that most banks would rather hold the loans in portfolio since they have significant demand for income-generating assets,” Nomura analysts wrote in the firm’s outlook.
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