Feb. 12 (Bloomberg) -- Traders are driving relative yields on Fannie Mae and Freddie Mac mortgage bonds that most influence the interest rates consumers pay to the lowest in 17 years, speculating cash the companies use to buy delinquent loans will be recycled back into the securities.
The difference between yields on Fannie Mae’s current- coupon 30-year securities, which trade closest to face value, and 10-year Treasuries narrowed to as little as 0.66 percentage point yesterday, matching the lowest since 1992, according to data compiled by Bloomberg.
Freddie Mac headquarters
Investors turned to the securities after the government- supported companies said they would buy about $200 billion of loans out of their mortgage bonds, mostly from higher-coupon debt, whose holders are now suffering losses following the announcement. The shift will leave investors with cash to reinvest as the Federal Reserve’s purchases of $1.25 trillion of home-loan debt ends next month.
“It’ll be a cushion for the end of the Fed program,” said David Cannon, global co-head of asset- and mortgage-backed securities at RBS Securities Inc. in Stamford, Connecticut, a unit of Royal Bank of Scotland Group Plc. “It probably makes sense for most of it to come right back into mortgages again,” he said, referring to the cash used to buy the delinquent loans.
Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of government debt was unchanged at 170 basis points yesterday, while overall yields rose to 4.16 percent from 4.14 percent a day earlier, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index.
Man Group Sells
Man Group Plc, the largest publicly traded hedge-fund company, sold 600 million euros ($821 million) of five-year bonds in its first issue in the common European currency. Life Technologies Corp., a provider of gene-analysis tools for medical research, sold $1.5 billion of debt to repay loans.
Benchmark gauges of risk in the U.S. and Europe fell after European leaders announced an agreement to contain Greece’s budget crisis.
European leaders promised to take “determined and coordinated action” on Greece if needed while ordering the country to get the euro-region’s biggest budget deficit under control. They stopped short of offering concrete steps to help Greece handle a debt load exceeding annual economic output.
Credit-Default Swaps
“There are a lot of questions that are going to need to be answered,” Marvin Barth, chief investment strategist at Santa Monica, California-based Tennenbaum Capital Partners LLC, said in an interview with Bloomberg Television. “In particular, what tests is Greece going to have to get whatever aid might be available.”
The Markit CDX North America Investment Grade Index, a credit-default swaps index linked to the debt of 125 companies, fell 3.25 basis points to a mid-price of 98.25 basis points yesterday, according to Barclays Capital. A decline signals improved perceptions of credit quality. Europe’s Markit iTraxx Europe index declined 0.5 basis point to 87.25 basis points, JPMorgan Chase & Co. prices show.
A basis point, or 0.01 percentage point, equals $1,000 a year on a contract protecting $10 million of debt.
Credit-default swaps on the SovX Western Europe Index, which is linked to the debt of 15 governments, rose 0.5 basis point to 95.5 basis points, according to CMA DataVision. Swaps on Greece fell 6 basis points to 350 basis points. Spain dropped 1.5 to 137.5 and Italy was unchanged at 129 basis points. Contracts on Portugal increased 13.5 basis points to 204.
‘Massive Exaggeration’
“Two years ago, the market thought there was no difference in risk between Greece, Spain and Portugal, and now people say they’re on the verge of default,” Pierre Cailleteau, head of global sovereign ratings at Moody’s Investors Service, said yesterday in an interview in New York. “That’s a massive exaggeration. That’s not a measured way to look at problems.”
Credit-default swaps are derivatives, or contracts with values derived from assets or events, including stocks, bonds, commodities, currencies, interest rates or the weather. Banks, hedge funds and insurance companies use the swaps to insure bonds and loans against default or to speculate on the creditworthiness of countries and companies.
The Fed started its purchases of mortgage bonds guaranteed by Fannie Mae and Freddie Mac or federal agency Ginnie Mae in January 2009, to lower home financing costs and bolster markets. The program is set to end by March 31, though officials have said it may be restarted if needed.
Home Loans
The rate on the average 30-year home mortgage fell to 5.13 percent on Feb. 10 from 5.36 percent at the start of the year and 6.43 percent in Aug. 2008, according to Bankrate.com.
The spread between those rates and 10-year Treasuries was 141 basis points yesterday, down from a high of 327 in Dec. 2008, and near the narrowest level since credit markets started to freeze in 2007.
Timing of the Feb. 10 announcements by Fannie Mae and Freddie Mac “appears more than coincidental,” said David Land, manager of the $142 million Ivy Mortgage Securities fund at Advantus Capital Management in St. Paul, Minnesota. “You’re going to get a ton of money back into the market.”
Spreads on Washington-based Fannie Mae’s current coupon securities closed yesterday at 67 basis points, down from 76 on Feb. 8, according to Bloomberg data, which uses a current-coupon index based on 4 percent and 4.5 percent securities.
Risk of Losses
Fannie Mae’s 6.5 percent securities fell to 107.46 cents on the dollar two days ago, from a record 108.25 the previous day, the steepest drop since July 2008, data compiled by Bloomberg show. McLean, Virginia-based Freddie Mac’s securities showed similar losses, though the pain for investors is larger because the prices reflect contracts for settlement next month when many of the loans may have been repurchased, analysts including Citigroup Inc.’s Brett Rose wrote in reports.
Fannie Mae’s 6.5 percent securities fell to 107.09 cents on the dollar yesterday, Bloomberg data show.
Investors who buy bonds for more than face value risk losses from the repurchases because they get fewer interest payments than they may have estimated. Fannie Mae and Freddie Mac would pay missed interest to bondholders if they didn’t repurchase the loans.
Prices for some interest-only slices of collateralized mortgage obligations backed by high-coupon securities underperformed hedges by about 2 cents on the dollar, falling to 19.75 cents yesterday from 21.03 cents on Feb. 9, according to RBS Securities data.
Portfolio Caps
“Dealers, who are in the business of carrying inventories in mortgage products are likely to be hurt considerably, in the beginning of the year, which bodes poorly for liquidity, especially with the Fed exit around the corner,” said Anish Lohokare, head of mortgage-bond strategy in New York at BNP Paribas.
The purchases will bring Fannie Mae and Freddie Mac close to their government-imposed portfolio caps, limiting their ability to buy securities if spreads widen as the Fed exits, he said in note to clients. He recommended investors avoid the market on the “possible turbulence.”
Investors shouldn’t assume cash returned to bondholders from the prepayments will be reinvested into the mortgage-bond market, because the owners include the Fed, Treasury Department, Fannie Mae, Freddie Mac, and Asian investors, said Scott Simon, head of mortgage bonds at Pacific Investment Management Co.
“Way over half the bonds live in accounts that won’t buy them back,” said Simon, whose Newport Beach, California-based firm manages the world’s largest bond fund.
Man Spreads
Man Group’s notes were priced to yield 345 basis points more than the benchmark mid-swap rate, which equates to 373.8 basis points over similar-maturity German government debt, Bloomberg data show.
The bond sale was London-based Man Group’s first since it raised $300 million through an issue of 11 percent perpetual securities in April 2008, according to data compiled by Bloomberg. Credit Suisse Group AG, JPMorgan Chase & Co. and Royal Bank of Scotland Group Plc managed yesterday’s sale.
Proceeds from the Life Technologies bonds will be used with cash on hand to repay the Carlsbad, California-based company’s outstanding indebtedness under a $1.33 billion term loan “A” facility and a $643 million term loan “B” facility, according to a filing with the U.S. Securities and Exchange Commission.
Life Technologies asked its lenders for a waiver to allow it to sell unsecured fixed- or floating-rate securities on Jan. 27, according to another regulatory filing.
To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net
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