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.
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.
Bond Sales Tumble
Sales of corporate bonds tumbled to $23.5 billion this week, 61 percent below the average over the previous year, according to data compiled by Bloomberg. 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.
Songa Offshore SE, the Norwegian owner of drilling rigs, and capacitor-maker Kemet Corp. postponed high-yield debt offerings in the U.S. yesterday, joining at least seven other companies that have pulled or delayed deals worldwide since Jan. 21, according to data compiled by Bloomberg.
Benchmark gauges of credit risk in Europe rose today after European leaders stopped short of offering concrete steps in their announcement that they’d reached 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.
‘Lot of Questions’
“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 credit-risk indexes extended their increase after China ordered banks to set aside more deposits as reserves for the second time in a month to cool the fastest-growing major economy.
High-Yield Bonds
The Markit iTraxx Crossover Index, a credit-default swaps index linked to the debt of 50 European companies with mostly high-yield credit ratings, climbed 21.5 basis points to 497.5, according to JPMorgan Chase & Co. prices at 10:09 a.m. in London. An increase signals a deterioration in perceptions of credit quality. The Markit CDX North America Investment Grade Index fell 3.25 basis points to a mid-price of 98.25 basis points yesterday, according to Barclays Capital.
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, were little changed at 94.5 basis points, according to CMA DataVision. Swaps on Greece were unchanged at 353.5, after soaring to a record 428 on Feb. 4, CMA prices show. Portugal fell 3 basis points to 202, Spain was unchanged at 137.5 and Italy fell 1 basis point to 128. Contracts on Portugal dropped 3 basis points to 202.
‘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.
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.
Less Interest
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.
“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.
Portfolio Caps
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.
China Reserve Rules
The reserve requirement for China’s banks will increase 50 basis points effective Feb. 25, the People’s Bank of China said on its Web site today. The current level is 16 percent for big banks and 14 percent for smaller ones. China’s policy makers aim to avert asset bubbles and restrain inflation after flooding the economy with money last year to drive the nation’s recovery from the deepest recession in generations.
In the U.K., 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 and sold $250 million of notes due 2013 in July of that year, 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
Last Updated: February 12, 2010 05:16 EST
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