Duh du jour:
Mon Nov 14, 2005 08:10 AM ET
By Julie Haviv
NEW YORK, Nov 14 (Reuters) - Pacific Investment Management Company, the biggest U.S. bond mutual fund, expects a slowdown in the housing market to negatively impact the value of certain mortgage-backed securities.
The combination of home affordability and interest-rate increases from the Federal Reserve will slow the U.S. housing market in 2006, which will probably cause prepayment speeds to slow, said Scott Simon, managing director and head of the mortgage and ABS teams at PIMCO.
Prepayment speeds are a key factor for determining the value of mortgage bonds.
"It (a slowdown in housing) will be much more upsetting to subordinated pieces of private label mortgage-backed and asset-backed securities than it will be on those backed by conventional 15- and 30-year mortgages backed by Fannie Mae (FNM.N,: Quote, Profile, Research) , Freddie Mac (FRE.N: Quote, Profile, Research) and Ginnie Mae," said Simon.
Private label securities are individually rated by Standard & Poor's, Moody's Investors Service and Fitch Ratings. Many of these subordinated securities are backed by mortgages to subprime borrowers, people with blemished credit histories.
Subordinated pieces take the first losses and are most exposed to any change for the worse in the housing market, he said in an interview with Reuters.
"If housing moderates without actually going down, there will be an increase in delinquencies and losses on the underlying mortgages in these deals," said Simon, who oversees over $150 billion in mortgage-related securities.
In addition, a slowdown in voluntary prepayment speeds will translate into more losses over a longer period of time, he said.
In the past when borrowers had trouble making their mortgage payments, some lenders allowed them to take equity out of their homes and refinance their mortgages instead. These borrowers, therefore, did not count as delinquencies in official data, but showed up as voluntary prepayments.
Historical data currently understates delinquencies and overstates voluntary prepayments by a very substantial margin, said Simon.
A mortgage-backed security, or MBS, is based on a pool of underlying mortgages. The analysis of MBS concentrates on the nature of the underlying payment stream, particularly the prepayments of principal prior to maturity.
Simon said the impact of a housing slowdown on MBS guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae will be "fairly small and somewhat esoteric" in size.
The three agencies are responsible for about $3 trillion of the $5.6 trillion MBS market. Private-label MBS issuance has exploded in size over the past few years, primarily stemming from a surge in subprime loans amid double-digit home price appreciation.
Private-label subordinate securities for the most part have ended up in collateralized debt obligations, or CDOs, and have been trading at their most expensive levels due to demand for the structured deals, according to Simon.
These CDOs offer higher yields than other securities, which is why demand has been so strong.
"If the housing market and economy slow, the CDOs have taken on the risk of potential losses because essentially they are underwriting the risk in the mortgage market," said Simon.
While these securities offer higher yields for a given rating level, they also usually have higher risk. Simon has been scaling back on CDOs over the past year.
Because investors structure and underwrite the mortgages for CDOs, the bonds are outside the banking system and regulatory agencies cannot police the sector, said Simon.
PIMCO looks at how delinquencies on mortgages have changed compared with the previous month and what types of loans are not behaving well since different loans have different implications.
That is why PIMCO tries to look at where delinquencies will show up geographically and among what borrower types, he said.
"The key is to be adequately compensated for the risk on certain bonds," said Simon. |
