Tags: Bernanke | Housing | Bonds | Federal Reserve

Bernanke's Faith in Housing Seen Shaken in Bonds

Thursday, 19 September 2013 01:29 PM

Borrowing costs for U.S. home buyers are poised to extend declines from the highest level in two years after the Federal Reserve unexpectedly refrained from slowing its debt buying and bolstered expectations for how long it will keep short-term interest rates at about zero percent.

A Bloomberg index of Fannie Mae securities that guide 30- year loan rates dropped about 0.2 percentage point Wednesday, the most since last September, to 3.39 percent, the least since Aug. 9. Yields soared as high as 3.81 percent on Sept. 5 from 2.28 percent in May as speculation mounted that the central bank would pare its $85 billion of monthly bond buying including $40 billion of government-backed mortgage securities.

After signaling his faith that real estate could weather increasing home-loan rates in June, Fed Chairman Ben S. Bernanke opted to exercise caution in reducing support for the economy.

He said Wednesday at a news conference in Washington that policy makers are seeking more information on how higher borrowing costs are affecting the housing recovery.

“I think they saw tightening financial conditions to be troublesome, especially when seeing the weaker housing data,” said Brad Scott, the head trader of pass-through agency mortgage securities at Bank of America Corp.’s Merrill Lynch unit in New York. “There were very few who were looking for no tapering.”

30-Year Mortgages

Rates on 30-year mortgages reached 4.93 percent in the week ended Sept. 6, the highest since April 2011 and up from a record low 3.57 percent in December, according to Mortgage Bankers Association data. The rate declined to 4.86 percent last week.

Builders began work on fewer U.S. homes than projected in August and applications for future work declined more than forecast, according to Commerce Department data released Wednesday that followed reports last month showing falling new and existing home sales and slowing property appreciation.

Fed officials “finally realized that housing is fading in anticipation of the tapering and even higher rates, and that they could not do it without irreparable damage to the housing recovery,” said Robert Bostrom, a former general counsel at Freddie Mac who’s now at law firm Greenberg Traurig LLP.

After the central bank announced its policy forecasts and the decision to sustain its bond purchases, futures trading signaled a 36 percent probability Wednesday that the Fed would lift the benchmark overnight rate by at least a quarter- percentage point at its December 2014 policy meeting. That’s down from 49 percent prior to the statement.

Borrowed Money

“It is essential for the Fed to convince the market of its commitment to keep rates low” because many holders of mortgage bonds use borrowed money in their investing, BNP Paribas SA analysts Anish Lohokare and Timi Ajibola wrote Wednesday in a report. Higher financing rates for buyers require steeper yields to maintain returns.

Elsewhere in credit markets, the cost to protect against losses on corporate bonds in the U.S. dropped to the least since May. Codere SA triggered credit-default swaps insuring $445 million of the Spanish gaming company’s debt by failing to make a bond payment on time.

Caesars Entertainment Corp. is raising $4.85 billion in bonds and loans to refinance obligations of the largest U.S. casino owner.

The Markit CDX North American Investment Grade Index, a credit-swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, fell 3.6 basis points to 69.5 basis points, the lowest level since May 8, according to prices compiled by Bloomberg.

European iTraxx

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings declined 0.7 to 93.4 in trading before the Fed announced its decision.

Both indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Codere’s delay constituted a failure-to-pay credit event, which causes settlement of all outstanding default swaps contract under the industry group’s rules, the International Swaps & Derivatives Association said on its website.

The Madrid-based company paid a coupon on $300 million of 9.25 percent bonds on Sept. 17, two days after the end of a 30- day grace period. The delay followed a Sept. 13 agreement with lenders to provide 35 million euros ($47 million) in additional debt as well as amendments to terms of outstanding loans.

Verizon Bonds

Bonds of New York-based Verizon Communications Inc. were the most actively traded dollar-denominated corporate securities by dealers Wednesday, accounting for 10 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The telephone carrier’s $15 billion of 6.55 percent, 30- year debentures, the biggest portion of a record $49 billion debt offering last week, jumped 2.1 cents to 111.55 cents on the dollar to yield 5.74 percent, Trace data show. The securities have surged from an issue price of 99.88 cents on Sept. 11.

The U.S. two-year interest-rate swap spread, a measure of debt market stress, rose 0.07 basis point to 15.88 basis points. The gauge typically widens when investors seek the perceived safety of government securities and narrows when they favor assets such as corporate bonds.

Leveraged Loans

The Standard & Poor’s/LSTA U.S. Leveraged Loan 100 Index held at about a one-month high, falling 0.01 cent to 97.92 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first-lien leveraged loans, has returned 3.5 percent this year.

Leveraged loans and high-yield, high-risk bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- at S&P.

A $3 billion term loan for Caesars is being arranged by Citigroup Inc., as well as a $269.5 million revolving credit facility, a person with knowledge of the transaction said. The Las Vegas-based gaming company also plans to issue $1.35 billion of second-lien notes and $500 million of first-lien debentures, according to a regulatory filing Wednesday.

In emerging markets, relative yields widened 2 basis points to 344 basis points, or 3.44 percentage points, according to JPMorgan Chase & Co.’s EMBI Global index. The measure has averaged 309.2 this year.

Reduction Expected

Economists had expected the Federal Open Market Committee to reduce its monthly Treasury purchases by $5 billion to $40 billion, while maintaining buying of mortgage-backed securities, according to a Bloomberg News survey. The FOMC has pledged for more than a year to press on with bond buying until achieving substantial labor market gains.

Among investors polled by JPMorgan analysts last week, 75 percent expected purchases of home-loan bonds to drop by $1 billion to $5 billion. The mortgage-bond analysts led by Matt Jozoff, who topped this year’s Institutional Investor magazine survey for research on the securities, forecast a $10 billion reduction in Treasury buying and $5 billion decline in mortgages in a Sept. 13 report.

Without a cut, the central bank is set to buy 88 percent of mortgage bonds being issued in the types of securities it’s targeting, a share that’s growing amid a slump in new loans to help homeowner refinance, according to Morgan Stanley analysts including Vipul Jain.

Refinancing Slump

Weekly applications to refinance mortgages have slumped 66 percent from a 2013 high, according to Mortgage Bankers Association data released Wednesday. Applications for loans to purchase properties have declined 15 percent on a seasonally adjusted basis since the start of May, and are just 1.3 percent higher than a year ago.

“We do want to see the effects of higher interest rates on the economy, particularly mortgage rates on housing,” Bernanke said Wednesday at the news conference.

At a similar event in June, the Fed chairman had said that building optimism about home prices could compensate for slightly higher mortgage rates.

LoanDepot.com, which has been originating about $1.3 billion of mortgages a month, is still anticipating that the era of record low rates is over, Chief Executive Officer Anthony Hsieh said Wednesday in a telephone interview.

“We all know the trend,” he said. “This is just an extra little stop that the mortgage industry will welcome. But make no mistake about it, rates are still going up over time from here.”

Liquidity Disruption

With higher rates having already choked off refinancing, monthly issuance of government-backed mortgage bonds is set to fall to $70 billion to $75 billion, down from an average of about $150 billion since last June, according to Morgan Stanley.

Along with the Fed’s $40 billion of new buying in the market, it has also been purchasing $31 billion a month under a program in which it reinvests proceeds from previous purchases, a figure set to fall to $10 billion to $15 billion with lower prepayments, the bank’s analyst estimated in a Sept. 6 report.

While Amherst Securities Group LP analysts had said the increasing share of Fed buying would pressure the central bank to cut back, Citigroup analysts said that investors shouldn’t jump to the conclusion that the central bank would need to taper to avoid disrupting the market’s liquidity.

There’s unlikely to be a “significant impact on refinancing activity” unless mortgage rates fall below 4 percent based on the current mix of existing loan rates and borrower credit profiles, said Scott Buchta, head of fixed- income strategy at New York-based brokerage Brean Capital LLC.

‘Capacity Constraints’

Unlike after the Fed began its latest round of bond purchases a year ago, mortgage lenders probably will pass on most of the recent decrease in mortgage bond yields to new borrowers, said Walt Schmidt, a Chicago-based mortgage strategist at FTN Financial.

“Part of that was capacity constraints” at lenders, which caused the firms to keep rates high to restrain demand, he said. Amid layoffs by lenders including Bank of America and Wells Fargo & Co. “you have fewer employees at originators now but also” even lower refinancing opportunities.

The Fed’s mortgage-bond purchases since September have expanded its holdings to almost $1.3 trillion, surpassing a previous peak of $1.1 trillion in June 2010 after an earlier round of buying initiated during the financial crisis sparked by Lehman Brothers Holdings Inc.’s failure five years ago.

Money managers, banks, overseas investors, real-estate investment trusts and government-sponsored companies such as Fannie Mae have all reduced their holdings during the round of purchases, even as the market grew by $170 billion to $5.3 trillion, according to Nomura Securities International analysts led by Ohmsatya Ravi.

Ginnie Mae

Housing starts rose 0.9 percent last month to an 891,000 annual rate, the Commerce Department said Wednesday. Pending existing home sales dropped 1.3 percent in July, the most this year, figures from the National Association of Realtors released Aug. 28 showed.

Purchases of new U.S. homes plunged 13.4 percent in July, the most in more than three years, to a 394,000 annualized pace, according to Commerce Department data released on Aug. 23.

The S&P/Case-Shiller index of property values in 20 cities released Aug. 27 showed prices rising 12.1 percent in June from the same month in 2012 after climbing 12.2 percent in the year ended in May, the biggest gain since 2006.

Mortgage securities guaranteed by government-supported Fannie Mae and Freddie Mac or U.S.-owned Ginnie Mae lost 2.8 percent from the end of April through Sept. 17, according to Bank of America Merrill Lynch index data.

Repo Market

Losses among Fannie Mae’s current-coupon securities, or those trading closest to face value and the largest target of the Fed’s buying, have been more extreme, totaling 8.3 percent since April, Bank of America Merrill Lynch index data show.

Expectations for when the Fed’s target for overnight loans will rise have contributed to the slump because yields on longer-term bonds mainly “represent the market’s expectation of short-term rates over time,” said Jim Vogel, a debt analyst at FTN Financial in Memphis, Tennessee.

Investors also funded $554 billion of government-backed home loan securities and $86 billion slices of repackaged mortgage bonds through short-term loans in the tri-party repurchase agreement market as of Aug. 9, according to monthly data from the New York Fed. The cost of one-month repo on agency mortgage Wednesday was 0.11 percent, down from as high as 4.55 percent in 2008, according to data from ICAP Plc, the world’s largest inter-dealer broker.

Real-estate investment trusts that rely on the borrowing owned $343 billion of the securities on March 31, while commercial banks, whose deposit costs are also tied to the Fed rates, now hold more than $1.3 trillion, central bank data show.

“Ability to fund cheaply remains critical for these levered carry trades,” as well investments often made by hedge funds known as inverse interest-only notes, the BNP analysts wrote.

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Borrowing costs for U.S. home buyers are poised to extend declines from the highest level in two years after the Federal Reserve unexpectedly refrained from slowing its debt buying and bolstered expectations for how long it will keep short-term interest rates at about zero percent.
Bernanke,Housing,Bonds,Federal Reserve
Thursday, 19 September 2013 01:29 PM
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