Mortgage Bonds Weather End of Fed’s Purchases: Credit Markets

April 12 (Bloomberg) -- Yields on mortgage bonds with government-backed guarantees fell relative to U.S. government debt in the first full week of trading after the Federal Reserve ended its unprecedented purchase program, bolstering credit for housing as the economy begins to create jobs.

Yields on Fannie Mae’s current-coupon 30-year mortgage bonds declined to within 0.66 percentage point of 10-year Treasuries last week, according to data compiled by Bloomberg. Spreads shrank after widening from a record low 0.59 percentage point on March 29 to 0.69 percentage point April 1, a day after the Fed completed its $1.25 trillion program.

Investors are betting that plans by Washington-based Fannie Mae and Freddie Mac in McLean, Virginia, to buy delinquent loans from securities they guarantee will return cash to holders who will invest the money back in the $5.4 trillion market, said Paul Norris of Dwight Asset Management Co. Spreads averaged 2.08 percentage points on Nov. 24, 2008, the day before the Fed said it would start buying the debt to ease credit for home loans.

“Spreads are probably going to hang in there for a little bit,” said Norris, who oversees $15 billion as a senior money manager at the Burlington, Vermont-based firm he joined from Fannie Mae last year.

Freddie Mac began its buyouts in February by repurchasing most loans already more than 120 days late, with Fannie Mae choosing to move at a slower pace. The initiatives by the government-supported companies, which are meant to cut their expenses, are equivalent to six to seven months of Fed purchases, according to Credit Suisse Group AG.

Spreads, Greece

Elsewhere in credit markets, the cost for companies to sell bonds fell for an eighth straight week, helping to accelerate the pace of debt offerings. Prices of high-yield, high-risk, or leveraged, loans also rose for the eighth week.

European governments put an aid package together worth as much as 45 billion euros ($61 billion) for debt-burdened Greece. Finance ministers from the 16 euro countries agreed they would offer three-year loans at an interest rate of about 5 percent, Luxembourg Prime Minister Jean-Claude Juncker said yesterday at a press conference in Brussels. Part of the total will come from the International Monetary Fund, he said.

Greek bonds climbed on April 9, trimming weekly declines, as speculation mounted a rescue accord was nearing completion. The yield on the two-year note slid 65 basis points to 7.16 percent after surging more than 250 basis points the previous three days. The 10-year bond yield declined 16 basis points to 7.21 percent.

Rising Yields

The extra yield investors demand to own corporate bonds instead of government debt fell 3 basis points last week to 146 basis points, or 1.46 percentage point, Bank of America Merrill Lynch’s Global Broad Market Corporate index shows. The spread is the narrowest since November 2007 and down from 176 basis points on Dec. 31 and the record 511 basis points in March 2009.

Yields overall rose to 4.04 percent from 4.02 percent. Corporate bonds have returned 2.85 percent this year, including reinvested interest, compared with 1.19 percent for government bonds, Bank of America Merrill Lynch indexes show.

Companies worldwide sold $31.2 billion of debt last week, up from $24.4 billion the previous period, according to data compiled by Bloomberg. Sales total $790.1 billion year-to-date, compared with $1.09 trillion at this point in 2009.

Growing Economies

Signs of an improving economy should help “risky” assets continue to outperform, according to debt strategists at New York-based JPMorgan Chase & Co. In a weekly report dated April 9, the bank recommended investment-grade and high-yield company bonds, “top quality” commercial mortgage bonds and securities backed by consumer loans.

“Given strengthening economic fundamentals, as well as limited supply in many asset classes, we remain positive on risky assets broadly,” the analysts including Srinivasan Ramaswamy, wrote in the report.

The economy of the Group of Seven nations grew 1.9 percent in the first three months of the year from the prior period on an annualized basis and will expand 2.3 percent in the current quarter, the Paris-based Organization for Economic Cooperation and Development said April 7.

A benchmark indicator of U.S. corporate credit risk rose last week. The Markit CDX North America Investment Grade Index Series 14, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 0.4 basis point to a mid-price of 85.5 basis points on April 9, according to Markit Group Ltd.

The index, which has fluctuated between 82.5 and 90 since the start of March after falling from 106.2 on Feb. 8, typically declines as investor confidence improves and rises as it deteriorates.

Russia Returns

Russian officials will meet with investors in Europe, Asia and the U.S. this week as the country seeks to sell foreign- currency bonds for the first time since 1998. The government said last year it may borrow as much as $17.8 billion abroad in 2010 to help plug its budget deficit and establish a new benchmark for corporate borrowing.

Meetings will be held in Frankfurt and Munich on April 13, London and Singapore on April 14 and London and Hong Kong on April 15, according to a banker with knowledge of the plans who declined to be identified because the terms weren’t set. In the U.S., the meetings will be held in Boston on April 16, Los Angeles on April 19, San Francisco on April 20 and will end in New York on April 21.

Loan Market

In the loan market, prices on the Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, ended last week at 92.25 cents on the dollar, the highest level since June 23, 2008, when the gauge closed at 92.28 cents.

Leveraged, or high-yield, loans are rated below Baa3 by Moody’s Investors Service and less than BBB- by S&P. About 20 billion of loans are in the pipeline as the market recovers, according to JPMorgan. About $22.3 billion of institutional loans have been completed since the end of February, compared with $38 billion for all of last year, the firm estimates.

The Fed began buying mortgage bonds in January 2009 to restrain financing costs amid the worst housing slump since the 1930s. Home prices in 20 metropolitan areas tumbled 33 percent from July 2006 through April 2009, then rose for five months before declining by a lesser amount over the next four, according to an S&P/Case-Shiller index.

Mortgage Rates

The market for so-called agency mortgage securities includes those guaranteed by Fannie Mae, Freddie Mac or U.S. agency Ginnie Mae. Yields on current-coupon bonds, or those trading closest to face value, are 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.

Yields on Fannie Mae’s securities declined to 4.54 on April 9, from an eight-month high of 4.67 percent on April 5, Bloomberg data show.

The average rate on a typical 30-year fixed-rate mortgage fell to a record low of 4.71 percent in the week ended Dec. 3, from last year’s high of 5.59 percent in June, before climbing to 5.21 percent in the week ended April 8, according to McLean, Virginia-based Freddie Mac. Rising yields on benchmark Treasuries amid record U.S. debt auctions and signs of an improving economy drove the advance, before recent drops.

Fannie Mae and Freddie Mac’s buyout programs targeted about $160 billion of loans more than four months delinquent, with “ongoing” purchases from newly soured debt likely to equal $100 billion to $120 billion, according to an April 8 report by Credit Suisse. The purchases most affect securities with higher coupons than current-coupon debt.

“Over the next months, spreads are probably going to head wider,” said Norris at Dwight Asset. “I’m not sure we’re seeing that money come back into the market.”

Seeking CMBS

Spreads for the Fannie Mae current-coupon securities on a so-called option-adjusted basis, a benchmark used by some investors that takes into account prepayment uncertainty, against interest-rate swaps have widened to 0.09 percentage point from as low as negative 0.22 percentage point on Dec. 21, according to Bloomberg data. That suggests some investors may be viewing spreads as more attractive.

Investors including banks and insurers may end up being more interested in using the money to buy commercial-mortgage- backed securities, which carry higher yields, or even Treasuries, whose maturities wouldn’t extend if benchmark rates rise, as happens with home-loan bonds’ cash flows as forecasted refinancing drops, Norris said.

Treasury Yields

Higher Treasury yields, or borrowing costs, often push spreads wider because the expected average lives of home-loan bonds and loan-servicing contracts increase as refinancing becomes less attractive, leaving holders with portfolios of longer-than-expected durations. Investors then may seek to pare durations by selling longer-dated Treasury securities, mortgage bonds and interest-rate swaps.

The most-senior commercial-mortgage securities yield 2.47 percentage points more than 10-year Treasuries, down from 4.25 percentage points at the start of the year, according to Morgan Stanley data.

“The market remains vulnerable” if prices of government notes decline and yields rise, New York-based Credit Suisse analysts led by Mahesh Swaminathan wrote in a report. That’s because Fannie Mae and Freddie Mac, whose on-balance-sheet holdings are capped under their support agreements, have typically been the most active buyers of mortgage bonds trading at “deep” discounts to face value, they said.