By Michael McDonald
Dec. 18 (Bloomberg) -- Homeowners may give the biggest Treasury rally in
four years a boost as falling bond yields trigger a rush to refinance
mortgages and increase demand for government debt.
Mortgage refinancing applications reached the highest level in a year this
month as average rates on 30-year home loans fell to a 14-month low,
according to the Mortgage Bankers Association. Demand for home loans helped
push yields on 10-year Treasuries to 4.4 percent on Dec. 1, the lowest since
January, because investors who own bonds backed by mortgages tend to buy
government debt when they get their money back early.
Another $100 billion in mortgage-backed securities may be repaid should
rates fall more, according to Dominic Konstam, head of interest-rate
strategy at Credit Suisse Group in New York. That would increase purchases
of Treasuries and help drive yields on 10-year notes to 4 percent, he
predicted.
``The market rallies, mortgages prepay, and all of a sudden people have to
buy,'' said Alec Crawford, head of agency and mortgage-backed strategy at
RBS Greenwich Capital in Greenwich, Connecticut. ``It can turn into
something that snowballs and causes the market to rally for a significant
period of time.''
The yield on 10-year notes, the benchmark for 30-year fixed- rate mortgages,
fell 1 basis point to 4.59 percent as of 12:48 p.m. in Singapore, according
to bond broker Cantor Fitzgerald LP. The price of the benchmark 4 5/8
percent note due in November 2016 rose 1/32 to 100 1/4.
Refinance Applications
Treasuries have gained 3.6 percent this year, the best since 2002, on
expectations the Federal Reserve will reduce its target rate for overnight
loans between banks next year. The central bank raised the rate 17 straight
times between June 2004 and June 2006, and left it unchanged at 5.25 percent
last week.
Increases in mortgage refinancing boosts Treasuries because investors who
get repaid typically reinvest in longer-maturity government bonds, which
benefit the most from falling interest rates, according to Konstam.
The Washington-based Mortgage Bankers Association said Dec. 13 its index of
applications to refinance loans rose 16 percent in the week ended Dec. 8 to
the highest since September 2005.
The average rate for 30-year fixed mortgage rose to 6.02 percent last week
from 5.98 percent in the week ended Dec. 8, according to the group. The rate
has fallen from a high this year of 6.86 percent in June.
Yields Drop
Mortgage-backed securities are created by pooling loans and selling bonds
with coupons based on the average underlying rates. About 60 percent of the
bonds in the U.S. are guaranteed by Fannie Mae, Freddie Mac and the
Government National Mortgage Association, or Ginnie Mae.
The yield on 30-year Fannie Mae securities fell to 5.49 percent on Dec. 1,
the lowest since September 2005, and was at 5.68 percent on Dec. 15.
About $500 billion in 30-year fixed-rate ``agency'' mortgage backed
securities had 6 percent coupons in early December, while about $800 billion
had 5.5 percent coupons, according to data from the issuers compiled by
Bloomberg. The longer the current coupon trades below these rates, the
greater chance the securities are paid off, according to Bear, Stearns &
Co., the largest underwriter of mortgage-backed securities.
``That puts us on the cusp of change,'' Steve Abrahams, a senior managing
director at Bear Stearns in New York, wrote in a Dec. 6 report. Refinancing
mortgage-backed securities ``would likely explode'' if 10-year Treasury
yields dropped below 4 percent, he wrote.
Less Equity
Mortgage bond investors helped push Treasury yields down by about 10 basis
points when they declined to 4.4 percent, according to Richard Volpe, head
of U.S. government bond trading at Bear Stearns.
Not everyone is convinced there is another spurt of refinancings coming.
Richard Kovacevich, chief executive officer in San Francisco at Wells Fargo
& Co., the second biggest mortgage lender, says the drop in U.S. home prices
made it less attractive to borrow money through refinancing.
``Rates have to go a lot lower to really get into a refinance boom, a true
refinancing boom, because everyone's refinanced'' in recent years,
Kovacevich said during an interview on Dec 12. ``You need another 50 basis
point or so.''
`Substantial Cooling'
Fed policy makers said in a statement accompanying their decision to leave
interest rates unchanged last week that there was a ``substantial cooling''
in the housing market. The median price of previously owned homes dropped
3.5 percent in October to $221,000, the biggest year-over-year decline on
record, according to the National Association of Realtors.
The realtors group also said this month that sales of existing homes will
increase at an annual rate of 6.29 million in the first quarter, snapping
five consecutive quarterly declines.
There are $6.2 trillion in mortgage securities outstanding, according to the
Securities Industry and Financial Markets Association, the largest segment
of the U.S. fixed income market. Foreign investors held about 10.7 percent
of the securities last year, up from 5.6 percent in 2003, according to UBS
AG.
Mortgage-related buying is an ``undercurrent'' that will drive Treasury
yields lower, said Steve Rodosky, a head of trading at Newport Beach,
California-based Pacific Investment Management Co., manager of the world's
biggest bond fund. Pimco is a unit of Munich-based Allianz SE. ``In order to
participate in the rally, they buy Treasuries,'' he said.
Scott Gormley
Broker/Owner
Oak Valley Mortgage
2006 Chico Assoc. of Realtors Affiliate Chairman
Direct: 530.592.8362
Fax: 530.267.5555
Website: http://www.CALoan.com
Blog: http://activerain.com/blogs/lendingmagician
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