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Home Buyers in US Seen Getting Boost From Taiwan Rule Change

Monday, 22 Sep 2014 02:41 PM

A change in regulations for Taiwan insurers may be proving a boon for U.S. home buyers.

That’s because new rules are allowing the companies to buy more callable bonds, which is stoking issuance of that debt and affecting derivatives markets that are used to gauge expectations for interest-rate volatility, according to JPMorgan Chase & Co.’s top-ranked mortgage-bond analysts.

Implied volatilities, or vols, play in a role in how much extra yield over benchmark rates investors demand to hold U.S.-backed mortgage bonds because they signal how erratic borrowing costs might be, and hence also the homeowner refinancing that guides how quickly they’ll be repaid. Lower vols are contributing to a drop in mortgage-bond spreads, including recent decreases linked to Taiwan, the JPMorgan analysts wrote in a Sept. 19 report.

The “tightening this year has been fueled by a remarkable decline in vols,” according to the analysts led by Matt Jozoff and Brian Ye, who were again ranked No. 1 for the market in this year’s Institutional Investor survey. And, “the most recent decline in vols, August in particular, can be traced to a surge of issuance of Formosa bonds in Taiwan.”

Formosa securities are notes that are registered domestically in the nation but denominated in a foreign currency. After a change in May, they’re exempt from regulatory limits on Taiwanese insurers’ foreign investments, according to a report last month from JPMorgan analysts led by Joshua Younger.

Issuance Surge

The result has been a surge in issuance of callable bonds that the insurers like to buy in the Formosa market for their higher yields, according to the bank.

The purchases affect the broader volatility market as the insurers turn to dealers to swap the fixed rate on the bonds into floating ones with derivatives, and then the dealers pass that risk on to investors such as hedge funds, asset managers and other insurers, Younger wrote.

The rise in Formosa callable sales since last month helps explain the recent renewed drop in implied volatilities, the JPMorgan mortgage-bond analysts wrote. The Federal Reserve’s unprecedented stimulus measures and investors’ comfort with its unwinding of them have contributed to longer-term declines.

Mortgage-bond holders can get their principal back faster or slower than they want as rates swing and refinancing among borrowers fluctuates. Options whose prices are used in calculations of implied volatility also provide a way for mortgage investors to hedge against rate swings, with the protection becoming cheaper as vols decline.

Tighter Spreads

Mortgage-bond spreads last week reached the tightest since January 2013, even as the Fed continued reducing its purchases of the debt on a pace that would end the acquisitions next month, one measure shows.

Yields on Fannie Mae securities used to package new 30-year loans fell to within 106 basis points of an average of five- and 10-year Treasury rates on Sept. 19, down from 117 basis points a month earlier and 122 basis points at the end of last year, according to data compiled by Bloomberg. A basis point is 0.01 percentage point.

The way that the mortgage-bond market looks different under an alternative measure known as option-adjusted spreads that takes volatility into account shows how important that item has been, the JPMorgan analysts wrote.

The OAS for the Fannie Mae securities climbed last week to 22 basis points from as low as 10 basis points in June, after ending 2013 at 23 basis points, according to Bank of America Merrill Lynch index data.

The average rate on typical 30-year mortgages rose 11 basis points last week to 4.23 percent as benchmark bond yields increased, down from about 4.5 percent at the start of this year, according to Freddie Mac surveys. Without tighter absolute spreads, borrowing costs would be even higher.

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A change in regulations for Taiwan insurers may be proving a boon for U.S. home buyers. That's because new rules are allowing the companies to buy more callable bonds.
home, Taiwain, callable bond, volatility
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2014-41-22
Monday, 22 Sep 2014 02:41 PM
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