Agency Mortgage-Backed Bond Spreads Reach Highest Since 1986
By Jody Shenn
March 5 (Bloomberg) -- The extra yield that investors demand to own agency mortgage-backed securities over 10-year U.S. Treasuries reached the highest since 1986, boosting the cost of loans for homebuyers considered the least likely to default.
The difference in yields on the Bloomberg index for Fannie Mae's current-coupon, 30-year fixed-rate mortgage bonds and 10- year government notes widened about 3 basis point, to 206 basis points, or 72 basis points higher than Jan. 15. The spread helps determine the interest rate homeowners pay on new prime mortgages of $417,000 or less. A basis point is 0.01 percentage point.
Some owners sold the securities ``to make room for the cheaper alternatives or to lighten up because they anticipated further unraveling'' in the financial markets, UBS AG analysts led by Laurie Goodman wrote in a report yesterday. Agency bonds, which are guaranteed by government-chartered companies Fannie Mae and Freddie Mac or federal agency Ginnie Mae, were the ``most liquid'' bonds they could sell, the analysts wrote.
Spreads are also widening as ``hedge funds continue to de- leverage,'' or scale back bond-secured borrowing, Noah Estrin, a strategist at RBS Greenwich Capital in Greenwich, Connecticut, wrote in a note to clients.
The spread for Fannie Mae's current-coupon securities over the average of yields on 5-year and 10-year Treasuries, a benchmark closer to their expected lives, was already the widest since 1986, according to Bloomberg data. That spread today rose to 260 basis points from 170 basis points on Jan. 15, the recent low. The similar spread for bonds backed by the U.S. government are also at the highest since the 1980s, at 224 basis points.
`Capital Constrained'
Agency mortgage-backed securities are an almost $4.5 trillion market. Bloomberg current-coupon indexes represent the average of yields for the two groups of bonds with prices just above and below face value.
The Fannie Mae current-coupon yield today is 5.73 percent. Investors are comparing that to yields of about 7 percent or more at which AAA rated, non-agency mortgage securities can be bought and tax-free yields of at least 5 percent to 6 on municipal bonds, according to Andrew Chow, who oversees about $6 billion in asset-backed bonds and derivatives at SCM Advisors LLC in San Francisco.
Spreads tightened last week when the regulator for Fannie Mae and Freddie Mac, two of the largest buyers of the securities they guarantee, announced that temporary caps on their $1.5 trillion portfolio would be lifted. Investors have realized that the step was unimportant because the companies remain ``capital- constrained,'' the New York-based UBS analysts wrote.
Option-Adjusted Spread
The UBS analysts, the top-rated team for agency ``pass- through'' mortgage securities in a 2007 poll by Institutional Investor magazine, reiterated their Feb. 25 recommendation for investors to hold a larger percentage of the securities than in benchmark indexes.
Average 30-year fixed mortgage rates climbed last week to 6.24 percent, from 6.17 percent in the last week of 2007, according to a survey by Freddie Mac. Yields on benchmark 10-year Treasuries last week fell to 3.51 percent, from 4.03 percent on Dec. 31. The Federal Reserve has cut its benchmark borrowing rate by 125 basis points so far this year.
The so-called option-adjusted spread of Fannie Mae's current-coupon securities matched the highest in at least 11 years yesterday, rising 18 basis points to 134 points, according to Merrill Lynch & Co. index data. That spread, which matches the spread on Feb. 21, is up from 81 basis points on Feb. 1.
An option-adjusted spread takes into account the impossibility of knowing when the underlying mortgages will be refinanced or otherwise paid off. Simple yield spreads also fail to take into account that borrowers' principal is paid down both sooner and later than the average lives of the securities.
Auction-Rate Failures
The spread between Fannie Mae's securities and 10-year Treasuries today surpassed a level last seen in April 2000. Spreads on non-agency mortgage bonds, commercial-mortgage bonds, and most types of asset-backed securities are at record highs, or near ones hit last month.
Spreads have been widening as banks remain limited in their ability to add new assets, as evidenced by failures in the $330 billion market for auction-rate bonds used by U.S. municipal borrowers. Almost 70 percent of the periodic auctions failed this week. Yields on the debt averaged 6.52 percent as of Feb. 28, up from 3.63 percent before demand evaporated in January. |
