After spike, mortgage rates look set to soften
Economic woes, reaction to F.D.I.C.'s bank bailout have kept rates high
10/22 01:23 PM
SAN FRANCISCO (MarketWatch) -- As investors cautiously catalogue signs that credit is starting to thaw, one important part of the debt market - mortgages - is taking a longer time emerging from deep freeze, pushing off a global financial recovery.
Still, there are some fresh signs from banks and the market for mortgage securities that home-borrowing costs may retreat soon, thanks to falling global interest rates and the government's plans to buy bad loans from banks.
"Everyone is hoping that this latest jump in mortgage rates and current level of mortgage spreads is temporary," said Nancy Vanden Houten, an economist with Stone & McCarthy Research Associates.
A survey of 170 mortgage originators conducted by HSH Associates and released on Tuesday showed lenders lowered the average rate of a 30-year fixed-rate mortgage to 6.16%, more than a half-point lower than last Wednesday's 6.75% but still higher than in early September when U.S. government moved to shore up the mortgage market by taking over Fannie Mae (FNM:$0.8000,$-0.1000,-11.11%) and Freddie Mac (FRE:$0.8503,$-0.0697,-7.58%) .
The HSH survey often foreshadows a more widely followed survey of lenders published by Freddie Mac (FRE:$0.8503,$-0.0697,-7.58%) every Thursday for the prior seven days.
Last week, Freddie Mac (FRE:$0.8503,$-0.0697,-7.58%) reported average mortgage rates spiked more than half a percentage point to 6.46%, the biggest move since 1987 and the highest level since late August.
In another reversal in mortgage rates, the Mortgage Bankers Association said Wednesday that rates on fixed-rate home loans dropped last week to 6.28% from 6.47% the previous week.
Spreads also signal retreat
Parts of the $6.7 trillion secondary market for mortgages are also showing modest signs of improvement from recent weeks, though trading levels still indicate investors are more nervous about mortgages than they were before the government announced several big initiatives to get credit flowing again.
Spreads on mortgage-backed securities compared to U.S. Treasurys - a common way to show moves in risk perception - have narrowed 28 basis points since Friday to 121 basis points, according to Merrill Lynch's U.S. Mortgage-Backed Securities Index.
Two years ago, in contrast, the spreads were under 50 basis points, according to Merrill Lynch.
One basis point is 1/100th of a percentage.
Narrower spreads indicate mortgage investors are less worried about payment risk and so aren't asking for higher rates to invest in these securitized pools of mortgages. That's key for homeowners: Banks, which sell the mortgages they originate to this secondary market, can lower the rates they charge on new loans when yields on mortgage-backed securities fall.
"People are feeling a little more confident. For one thing, Libor is dropping," said Roseanne Briggen, an analyst at Informa Global Markets.
As the benchmark London interbank offered rate falls, banks find it easier to lend to each other, freeing up capital to buy mortgage-backed securities and make new loans.
Nonetheless, spreads on mortgage-backed securities are wider than they were in the second week of September after the U.S. government put Fannie Mae (FNM:$0.8000,$-0.1000,-11.11%) and Freddie Mac (FRE:$0.8503,$-0.0697,-7.58%) into conservatorship - echoing the trend in mortgage rates. The government's landmark decision followed weeks of speculation that the mortgage finance companies could fail because of mounting problem loans, jeopardizing their roles as the biggest buyers of U.S. mortgages.
"The initial optimism that Fannie Mae (FNM:$0.8000,$-0.1000,-11.11%) and Freddie Mac (FRE:$0.8503,$-0.0697,-7.58%) weren't going out of business caused a downdraft in rates," said Keith Gumbinger, vice president at HSH Associates.
But that optimism faded in subsequent weeks as concerns about the economy put more pressure on outstanding mortgage-backed securities, said Gumbinger and others.
Last week, investors digested news that industrial production and retail sales plunged in September while housing starts dwindled to their second-lowest level in half a century.
Hedge funds, meanwhile, have been unloading liquid assets to cover losses in commodities related stocks. Those sales likely included mortgage-related securities, analysts said.
Plus, the U.S. Federal Deposit Insurance Corp.'s announcement last week that it would guarantee bank debt likely prompted some investors to sell their mortgage-related debt in favor of higher-yielding bank debt that now comes with government banking.
"Some of the bank paper had got so incredibly wide, it was trading at junk-bond levels," said Roseanne Briggen, an analyst at Informa Global Markets. With the FDIC guarantee, "that's incredibly attractive."
The ripple affect of the FDIC program helped widen spreads on debt issued by the government-sponsored enterprises in the past week, analysts say. And these wider spreads may have prompted Fannie Mae (FNM:$0.8000,$-0.1000,-11.11%) to cancel an auction of its benchmark notes for the first time this year.
"Absolutely I think they cancelled it because spreads were so wide," said Briggen.
Higher spreads on these government agencies' own debt make it harder for them to accept lower rates from mortgages they buy from lenders.
Fannie Mae (FNM:$0.8000,$-0.1000,-11.11%) spokesman Jason Lobo said the firm would not comment on the cancelled auction except to say the company had previously notified investors that it may forego any one month of issuance.
Spreads on mortgage agency debt have only just started to shrink again.
On Tuesday, the spread between Fannie Mae's (FNM:$0.8000,$-0.1000,-11.11%) 10-year bond and Treasurys fell 15.3 basis points to 95.8 after reaching as high as 110.8 basis points last week.
Still, recently narrowed spreads are trading well over the average 67.7 basis points for the year and last year's 45 basis points.
"The widening gained steam when the U.S. said it would back, through the FDIC, some new bank debt," said Tony Crescenzi, chief bond market strategist at Miller Tabak & Co., in a note to investors.
"The narrowing probably reflects a sense that yields on agency securities have moved too far from Treasuries given the U.S. government's seizure" of the firms, he said.
Analysts say a retreat in mortgage rates is only a matter of time, given the U.S. government's radical and numerous programs to get credit flowing again. Besides investing directly in banks and assuming control of Fannie Mae (FNM:$0.8000,$-0.1000,-11.11%) and Freddie Mac (FRE:$0.8503,$-0.0697,-7.58%) , it has pledged to buy illiquid mortgage-backed securities from banks under the $700 billion Troubled Asset Relief Program, or TARP.
Mortgage-backed securities spreads "in the mid-term would come back slightly but not in a big fashion unless the GSEs, Treasury, or the TARP program steps up the actual buying of illiquid securities," said Derek Chen, fixed-income analyst at Barclays Capital.
