CORRECT: Quest For Yield Drives Even Skeptics To Mortgages
August 27 2010 - 5:12PM
Dow Jones News
Mortgage securities, especially those carrying higher rates of
interest, are back in favor.
This week, investors seemed to have found their appetites for
these bonds as the fear of a sharp spike in refinancings by
homeowners and a surge in home sales abated.
Instead, buyers were focused on the need to invest cash and the
higher yields on these securities over comparable Treasury
yields.
Some market observers are calling this a capitulation,
especially by domestic portfolio managers who shunned mortgage
securities all year and groused that prices were too high.
Now, it's September, prices remain elevated, and fund managers
who put their money in other short-term investments, which are
beginning to mature, are going back to mortgage bonds. They say
that despite the prices, these bonds offer irresistible
yields--about 150 basis points over comparable Treasurys. Dealers
also recommend them to their clients.
"Not everybody is in love with this market," said Michael Graf,
head of U.S. short rates trading at Barclays Capital, "but they are
not in love with the alternative, which is sitting on cash."
On Friday, in a move that could draw even more buyers into the
market, prices on mortgage bonds fell sharply. The downward
pressure was primarily due to underperformance of Treasury bonds
and selling of new mortgage bonds into the market.
The lower coupons felt the bulk of the pressure, as securities
backed by mortgages issued in the last few months are likely to
carry a coupon of 4% to 5%. The Fannie 30-year bond with a 4%
coupon dropped 15/32 or $4,687.50 for every $1 million in
investment.
However, the higher coupons fared better. Prices on the Fannie
6.5% bond was slightly lower by 2/32 at 108-24, according to
Tradeweb data.
Much of this is because investors have realized that these
securities, with interest rates of 5.5% and higher, overcorrected
in the past month. Speculation and fear that the government would
initiate a refinancing program for borrowers who wouldn't otherwise
qualify for a new loan in the current stringent lending
climate--such as people who owe more than their homes are now
worth--led to prices on these bonds to crater. Investors feared
that these bonds, which were trading for more than 109 cents per
dollar of face value because of their high interest payouts, would
be redeemed at face value.
However, those rumors now mostly have been put to rest.
"[These] coupons are benefiting as actual prepayments are likely
to fall short of market expectations," according to Barclays
analysts.
Despite this prediction, prepayments could prove to be a risk on
bonds that were newly issued in 2009 and 2010, which carry a 4%,
4.5% and 5% rate of interest. These bonds are backed by loans made
in the past 18 months to borrowers with high credit.
With 30-year fixed-rate mortgage rates currently averaging
4.36%, according to the latest Freddie Mac survey, and with
expectations that they will drop in coming months, it starts making
economic sense for some of these borrowers to refinance despite the
fees they have to pay.
The volume of homeowners looking to refinance picked up in the
last couple of weeks, but it will be a short wave with not too much
of an impact, said Mahesh Swaminathan, strategist with Credit
Suisse.
-By Prabha Natarajan, Dow Jones Newswires; 212-416-2468;
prabha.natarajan@dowjones.com