Agency Mortgage-Backed Bond Spreads Reach Highest Since 1986

Bloomberg reports:

The extra yield that investors demand to own agency mortgage-backed securities over 10-year U.S. Treasuries reached the highest since 1986, boosting the cost of loans for homebuyers considered the least likely to default.

The difference in yields on the Bloomberg index for Fannie Mae's current-coupon, 30-year fixed-rate mortgage bonds and 10- year government notes widened about 12 basis points, to 215 basis points, or 79 basis points higher than Jan. 15. The spread helps determine the interest rate homeowners pay on new prime mortgages of $417,000 or less. A basis point is 0.01 percentage point.

Some owners have been selling the debt ``to make room for the cheaper alternatives or to lighten up because they anticipated further unraveling'' in the financial markets, UBS AG analysts led by Laurie Goodman wrote in a report yesterday. Agency securities, which are guaranteed by government-chartered companies Fannie Mae and Freddie Mac or federal agency Ginnie Mae, were the ``most liquid'' bonds they could sell, they wrote.

Spreads are also widening as ``hedge funds continue to de- lever,'' or scale back bond-secured borrowing, wrote Noah Estrin, a strategist at RBS Greenwich Capital in Greenwich, Connecticut, in a note to clients today. Banks and securities firms are raising the collateral they require on loans or taking other steps that discourage borrowing, according to Don Brownstein, chief executive officer of Structured Portfolio Management LLC.

The spread for Fannie Mae's current-coupon securities over the average of yields on 5-year and 10-year Treasuries, a benchmark closer to their expected lives, was already the widest since 1986, according to Bloomberg data. That spread today rose to 270 basis points from 170 basis points on Jan. 15, the recent low. The similar spread for bonds backed by the U.S. government is also at the highest since the 1980s, at 233 basis points.

Buyers Strike

``There's basically a buyer's strike right now,'' said Brownstein, whose Stamford, Connecticut-based manager of fixed- income hedge funds with about $1.2 billion in assets. With lending against bonds tightening, spreads need to widen ``to make the un-leveraged assets more or less as attractive as they were when leverage was available,'' he said.

Agency mortgage securities outstanding total almost $4.5 trillion, roughly the same size as the U.S. Treasury market. Bloomberg current-coupon indexes represent the average of yields for the two groups of bonds with prices just above and below face value, the ones that lenders typically package new loans into.

The Fannie Mae current-coupon yield today is 5.84 percent. Investors are comparing that to the yields of about 7 percent or more at which AAA rated, non-agency mortgage securities can be bought and tax-free yields of at least 5 percent to 6 percent on municipal bonds, said Andrew Chow, who oversees about $6 billion in asset-backed bonds at SCM Advisors LLC in San Francisco.

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