Mortgage Bonds Face Eye of Storm as Refinancings Decline: Credit Markets
Housing Stress Rises Despite Fed's Efforts
Joshua Lott/Getty Images
Homeowner Marie Piantino waits to see if she qualifies for a home modification loan in Phoenix.
Homeowner Marie Piantino waits to see if she qualifies for a home modification loan in Phoenix. Photographer: Joshua Lott/Getty Images
Mortgage Bonds in Eye of Storm as Refis Decline
Victor J. Blue/Bloomberg
Bonds of Charlotte, North Carolina-based Bank of America Corp. were the most actively traded U.S. corporate securities by dealers yesterday.
Bonds of Charlotte, North Carolina-based Bank of America Corp. were the most actively traded U.S. corporate securities by dealers yesterday. Photographer: Victor J. Blue/Bloomberg
Investors in U.S. government-backed mortgage bonds who benefited from a decline in early payoffs by homeowners are bracing for the fallout from a loosening of refinancing rules at Fannie Mae (FNMA) and Freddie Mac.
Prepayments for Fannie Mae’s 30-year fixed-rate securities fell 8 percent last month to a pace that would erase 21.6 percent of the debt in a year, the slowest since September, data released Feb. 6 by the Washington-based company show. Refinancing damages securities that trade for more than face value by returning principal faster at par and curbing interest.
An expansion of the Home Affordable Refinance Program urged by President Barack Obama is set to boost speeds by 1 or 2 percentage points each month, Barclays Capital analysts wrote in a report this week titled, “Calm Before the Storm.” More homeowners with the cheapest mortgages who don’t need HARP are also seeking new loans as average rates on 30-year debt ease, falling to a new nadir of 3.87 percent last week.
“For the first time in this entire period of tight credit and other challenges, there is real concern amongst investors” that betting against refinancing is risky, said Brad Scott, Bank of America Corp.’s head trader of pass-through agency mortgage securities in New York. “People are anticipating HARP will be real and that the program will be fairly effective, and are bracing for higher speeds going forward with the next print.”
Mortgage-bond buyers are preparing for the effects of adjustments for Fannie Mae and Freddie Mac borrowers with little or no home equity announced in October, while downplaying risks from the further loosening that Obama said Feb. 1 he will seek to create with help from Congress.
Default Swaps Rise
Returns in the $5.3 trillion market for U.S. government- backed mortgage bonds beat Treasuries in December and January after concern that the president would accelerate refinancing fueled losses in four of the prior five periods, Barclays Capital index data show. The outperformance this month has totaled 23 basis points through yesterday.
Elsewhere in credit markets, a benchmark gauge of U.S. credit risk rose, with the Markit CDX North America Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, rising 0.9 basis point to 95.9 basis points as of 12:07 p.m. in New York, according to Markit Group Ltd.
The index, which typically falls as investor confidence improves and rises as it deteriorates, has climbed from 94.3 basis points at the end of last week, the lowest level since July.
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.
Noble Bonds
The U.S. two-year interest-rate swap spread fell 1.3 basis points to 28.69 basis points as of 12:07 p.m. in New York. The measure of stress in credit markets, which had climbed 3.63 basis points in the past three days from a five-month low, widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.
Bonds of Noble Corp. (NE) were the most actively traded U.S. corporate securities by dealers yesterday, with 175 trades of $1 million or more as of 12:08 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The Swiss offshore drilling contractor sold $1.2 billion of bonds yesterday in its first offering in more than a year.
At current mortgage rates, about 95 percent of the $2.8 trillion of 30-year loans packaged into Fannie Mae and Freddie Mac securities stand to gain from refinancing based on typical closing costs, according to JPMorgan analysts led by Brian Ye. About a third of the borrowers face the types of qualification challenges HARP is meant to address, they said.
Slower Timeline
Mortgage bonds guaranteed by government-supported Fannie Mae and Freddie Mac or U.S.-owned Ginnie Mae outperformed similar-duration Treasuries by a total of 30 basis points in December and January, according to Barclays Capital index data. The debt underperformed by 198 basis points in the second half of 2011.
Trading yesterday initially reflected relief that prepayments slowed, before investors reassessed the data and concluded that it only signaled a slower timeline on use of the HARP expansion, Bank of America’s Scott said in a telephone interview. With last month “just too soon to encompass the impacts,” that may mean data on speeds released in March may be higher than expected, he said.
Fannie Mae’s 6.5 percent securities, whose underlying loans’ rates average about 7 percent, rose about 0.3 cent to 112.2 cents on the dollar as of 11:44 a.m. in New York, the highest since August. That compares with 109.7 cents on Oct. 3 and a record 113.6 cents on June 7, Bloomberg data show.
Push for Adjustments
“The big overhang in the market is just how effective the HARP 2.0 changes will be,” said Bryan Whalen, co-head of mortgage bonds at Los Angeles-based TCW Group Inc. which oversees $118 billion. “The fact that we didn’t see it this month was a small relief. But investors are going to wait to see how next month’s print will go.”
Obama created HARP in 2009 as refinancing was curbed by lower incomes, tightened lending standards and the worst decline in U.S. home prices since the Great Depression. After the initiative reached less than a quarter of the 4 million to 5 million projected, the president pushed for adjustments last year. The resulting changes, including lower fees and lessened risks for lenders, began in December and some won’t start until March or later.
While the Federal Housing Finance Agency, the independent regulator that oversees Fannie Mae and Freddie Mac, said that the tweaks might double HARP’s reach, a Fed paper sent to Congress last month by Chairman Ben S. Bernanke said policy makers should consider expanding it further.
Refinancing Speeds
Obama responded by preparing legislation to force further changes, including making it easier for lenders to refinance Fannie Mae and Freddie Mac loans they don’t service. The bill would also expand refinancing opportunities for borrowers without government-backed debt.
There is “a low probability of it passing Congress,” Barclays Capital analysts Derek Chen and Wei-Ang Lee wrote Feb. 6 in their report. At the same time, investors may have “shrugged it off a bit too quickly,” with a “tail risk” being the potential for Obama to expand HARP to mortgages made after May, 2009, they added.
Last year’s changes mean that refinancing speeds among potential HARP-eligible loans will probably rise about 40 percent over the next year, the analyst wrote in the report.
‘Many Surprises’
Fannie Mae prepayment speeds will probably peak in March at almost 28 percent, rising partly because of lower rates and lenders rushing to close loans before an increase in Fannie Mae and Freddie Mac bond-insurance costs created by Congress, according to the JPMorgan analysts, the top-ranked for prepayment strategy last year in a poll by Institutional Investors magazine. Barclays Capital had the second-ranked team.
“Investors will face many surprises” in prepayments on the highest-rate loans “in the months ahead, both on the upside and occasionally on the downside,” the JPMorgan analysts said.
The average rate on a typical 30-year mortgage reached 3.87 percent in the week ended Feb. 2, after averaging about 3.97 percent in November and December, according to McLean, Virginia- based Freddie Mac. That’s down from last year’s high of 5.05 percent in February. Loans usually close between one and three months after applications.
Refinancing Soars
Refinancing applications almost tripled from last year’s low in February through the week ended Aug. 12, before falling by 42 percent through late November, according to Mortgage Bankers Association surveys. As rates moved even lower, giving more borrowers an incentive to refinance, the pace gained 59 percent, data released today show.
In his State of the Union address last month, Obama said he wants to give “every responsible homeowner the chance to save about $3,000 a year on their mortgage by refinancing at historically low interest rates.”
TCW’s Whalen said that “the market expectations look to be correct in that we’ll see a pick-up and some additional borrowers will refi, but that it’ll fall short of anything material.” The potential for policy makers to act if prepayment speeds fail to gain enough in the coming months represents an “ongoing 2012 risk,” he said in a telephone interview.
“If HARP 2.0 doesn’t really get any legs and the type of pick-up that the administration wants, you could see more programs get enacted,” he said. “You have to respect that.”
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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