The Hutchens Blog

The rally among home-loan bonds without government backing is being fueled by errors made by “most market participants” in translating current prices to potential returns, Amherst Securities Group LP analysts said.

Investors are overestimating potential yields in part because they are failing to consider how many loans are becoming delinquent for the first time and partly because they are arriving at incorrect conclusions on how long it will take to liquidate seized homes, the New York-based analysts led by Laurie Goodman wrote in a report yesterday. Those issues can influence both the size of foreclosure losses and how quickly bonds get paid down.

“Do your homework, and sell securities which are being evaluated incorrectly by the marketplace,” the analysts wrote.

Non-agency home-loan bonds have soared from record lows or near-nadirs in March amid speculation that Treasury Secretary Timothy Geithner’s Public-Private Investment Program, or PPIP, will add as much as $40 billion of demand to the market, and that the longest U.S. recession and worst housing slump since the Great Depression are easing.

For example, the most-senior classes of 2006 and 2007 securities backed by prime-jumbo mortgages have rallied to more than 80 cents on the dollar, from as low as 55 cents, according to Amherst. So-called super-senior bonds backed by “option” adjustable-rate mortgages have jumped to about 48 cents, from the “low 30s,” the analysts wrote.

Insufficient Analysis

Investors also have been doing too little analysis of the differences, such as the level of home equity, among borrowers with currently non-delinquent mortgages backing non-agency bonds, which lack guarantees from government-supported Fannie Mae and Freddie Mac or U.S. agency Ginnie Mae, they said.

After correcting two of the three common mistakes by investors, the potential yield on a Countrywide Financial Corp.- issued option ARM bond now trading at 48 cents on the dollar would fall to 6.49 percent, from 12.67 percent, assuming the London interbank offered rate remains unchanged, Amherst said. Adjusting for all three reduces the yield on a Wells Fargo & Co. jumbo-mortgage note bought at 85 cents to 7.15 percent from 11.52 percent, the analysts wrote.

That is “much lower than most market participants believe they are receiving on the security,” they said. “Moreover, the yield must be evaluated in conjunction with the level of uncertainty about our assumptions” around whether borrowers will continue to refinance at the “fast” pace of recent months and how many borrowers with “negative equity” will default.

Third Point Profits

Scott Simon, mortgage-bond chief at Newport Beach, California-based Pacific Investment Management Co., the world’s largest fixed-income manager, told Bloomberg Television on Aug. 4 that “from a long-term point of view, a lot of this paper still will yield a lot after losses.”

A buyer last quarter of at least some kinds of home-loan bonds was Third Point LLC, the hedge fund run by Daniel Loeb, which entered the market amid lower prices after profiting from bets against subprime-mortgage bonds in 2007, according to a July 31 investor letter from the New York-based firm.

Third Point bought $160 million in mortgage bonds and made more than $20 million in profits from April through July, Loeb wrote. He estimated that under “severe economic distress” where all of the underlying loans default and home prices drop another 20 percent, the debt the fund held as of June 30 would return 10 percent based on the prices it paid. The debt would return 17 percent to 20 percent under “our base case economic assumptions,” he said.

Pleased Investor

Loeb may “eventually” increase his fund’s mortgage-bond investments to 10 percent to 15 percent of invested capital, up from a previous target of 5 percent to 10 percent, depending on other opportunities, he said.

“Although four months is certainly too brief of a period to ‘declare victory’ in the mortgage markets, I am pleased with our timing, security selection, and ability to obtain choice offerings from the Street,” Loeb said.

Goodman is the former head of fixed-income research at UBS Securities LLC whose team there was top-ranked for non-agency mortgage debt in a 2008 poll of investors by Institutional Investor magazine. Amherst is a securities firm specializing in trading and advising investors on home-loan debt.

The U.S. government announced July 8 that the PPIP would begin with nine managers raising as much as $10 billion, and receiving as much as $30 billion in taxpayer capital and loans to buy mortgage bonds originally rated AAA.

Option ARMs

Jumbo mortgages are larger than Fannie Mae or Freddie Mac can finance, currently $417,000 in most areas to as much as $729,500. Option ARMs allow borrowers to pay less than the interest they owe, tacking on the difference to their debt and creating the potential for bills to spike.

A Markit ABX index of credit-default swaps tied to a type of subprime-mortgage bond rated AAA when issued in the first half of 2007 climbed to 29 yesterday, up 18 percent from a June low, according to Markit Group Ltd.’s Web site. The swaps offer protection if the securities aren’t repaid as expected, in return for regular insurance-like premiums. Subprime mortgages went to borrowers with poor or limited credit or high debt.

Posted by Sandy Hutchens

A jump in oil prices helped widen the U.S. trade deficit in June, but a sharp fall in manufactured goods exports and imports appears to have stabilized, a Commerce Department report showed on Wednesday.

The monthly trade gap totaled $27.0 billion, up 4.0 percent from May. The shortfall was smaller than many analysts expected because stronger foreign demand for U.S. goods and services offset some of the impact of higher oil prices.

Both U.S. exports and imports remained sharply below records reached in July 2008, just before the global financial crisis began wreaking a savage toll on international trade.

But “the sharp decline in U.S. exports and imports of manufactured goods appears to be stabilizing,” said Frank Vargo, vice president for international economic affairs at the National Association of Manufacturers.

For the fourth month in a row, U.S. manufactured goods exports totaled roughly $67 billion and manufactured goods imports were roughly $93 billion, Vargo said.

The trade gap for the first six months of 2009 totaled nearly $173 billion, down more than 50 percent from the same period last year. Year-to-date exports were down 19.3 percent from 2008, while imports were off 28.8 percent.

The smaller-than-expected June deficit was, by itself, good news for the U.S. economy, which is beginning to show signs of emerging from a recession that began in December 2007.

“However, other data already released on construction and inventories point to a downward revision” of second quarter GDP growth to -1.6 percent from -1.0 percent,” said Nigel Gault, chief U.S. economist at IHS Global Insight.

Looking ahead, the monthly gap between imports and exports should widen in the second half of the year as producers and retailers restock currently lean inventories.

So, unlike the first half of 2009, “trade will become a drag on growth. But that would be a drag in a context where both exports and imports are growing, as the U.S. and global economies climb out of recession,” Gault said.

OIL PRICE UP

U.S. imports of goods and services rose 2.3 percent in June to $152.8 billion, the highest since January. Higher oil prices accounted for much of the increase, and imports of consumer products fell to the lowest since November 2005.

The average price for imported oil rose for the fourth straight month to $59.17 per barrel, helping to widen the U.S. trade gap with the Organization of Petroleum Exporting Countries to the highest since October 2008.

U.S. exports rose 2.0 percent in June to $125.8 billion, led by stronger foreign demand for industrial supplies and materials and capital goods.

Exports of foods, feeds and beverages were the highest since October 2008.

U.S. home loans failed at a record pace in July despite ongoing federal and state programs to avoid foreclosures, which have severely strained housing and the economy.

Foreclosure activity jumped 7 percent in July from June and 32 percent from a year earlier as one in every 355 households with a loan got a foreclosure filing, RealtyTrac said on Thursday.

Filings — including notices of default, auction and bank repossession — have escalated with unemployment.

“July marks the third time in the last five months where we’ve seen a new record set for foreclosure activity,” James J. Saccacio, RealtyTrac’s chief executive, said in a statement.

“Despite continued efforts by the federal government and state governments to patch together a safety net for distressed homeowners, we’re seeing significant growth in both the initial notices of default and in the bank repossessions.”

More than 360,000 households with loans drew a foreclosure filing in July, a record dating back to January 2005, when RealtyTrac started tracking monthly activity.

Notices of default, auction or repossession have reached nearly 2.3 million in the first seven months of the year — with more than half a million bank repossessions, the Irvine, California-based company said.

Making timely payments keeps getting harder for borrowers who have lost their jobs or seen their wages cut.

The unemployment rate is 9.4 percent and President Barack Obama has said he expects it will hit 10 percent.

Obama’s housing rescue is gaining traction in altering terms of loans for struggling borrowers, but slowly.

Earlier this month the U.S. Treasury Department detailed the progress of the top servicers in modifying loans and prodded them to step up efforts to stem foreclosures.

SUN BELT STILL SUFFERING

States where sales and prices surged most in the five-year housing boom early this decade remain hardest hit.

California, Florida, Arizona, Nevada accounted for almost 57 percent of total U.S. foreclosure activity in July.

Illinois had the fifth-highest total filings, spiking nearly 35 percent from June, in an example of how moratoriums often delay rather than cure an inevitable loan failure.

Default notices spiked by 86 percent in July, from artificially low levels the prior two months. A state law enacted on April 5 gave delinquent borrowers up to 90 extra days before foreclosure started, RealtyTrac said.

Michigan’s foreclosure activity fell 39 percent in July from June, mostly due to a 66 percent drop in scheduled auctions. A state law that took effect July 6 freezes foreclosure proceedings an extra 90 days for homeowners who commit to work on a loan modification plan.

Other states with the highest foreclosure filing totals last month included Texas, Georgia, Ohio and New Jersey.

Nevada had the highest state foreclosure rate for the 31st straight month, with one in every 56 properties getting a filing, or more than six times the national average.

Initial notices of default fell 18 percent in the month, with a new Nevada law taking effect on July 1 requiring lenders to offer mediation to homeowners facing foreclosure. Scheduled auctions and bank repossessions each jumped more than 20 percent, however, boosting overall foreclosure activity in the state by 4 percent from June.

California, Arizona, Florida, Utah, Idaho, Georgia, Illinois, Colorado and Oregon were the other states with the highest foreclosure rates.

The cost of fixed-rate mortgages rose to its highest level for ten months as more borrowers took out loans to buy new homes, according to figures published yesterday.

The Bank of England said that the average five-year, fixed-rate mortgage had risen from 5.54 per cent to 5.7 per cent between June and July, the highest level since October 2008, when the base rate was 4.5 per cent, compared with 0.5 per cent now.

Meanwhile, the number of homeowners taking out a mortgage to buy a home rose by 23 per cent to 45,000 in June, the highest for a year, according to the Council of Mortgage Lenders, after a rise in demand from new homebuyers.

Economists said that mortgage rates would continue to rise for the rest of the year, stifling the market at a time when demand for fixed-rate mortgages was increasing. Rate rises are a result of lenders passing on the higher cost of funding but also reflect bigger margins and a reluctance by banks to take on new business.

Paragon Mortgages, a lender, said that a record seven in ten buyers had applied for fixed rates in the three months to June as borrowers looked to capitalise on an historically low base rate. However, those opting for trackers, which follow the base rate, fared better: the average rate of these deals stayed the same at 3.81 per cent.

Separate government figures yesterday from the Department for Communities and Local Government showed that high demand relative to low supply had contributed to a 1.6 per cent rise in house prices in June to £191,423, bringing the annual fall from June to June to 10.7 per cent in England. The average price paid by first-time buyers rose by 2 per cent between May and June to £140,222.

Knight Frank, an estate agency focusing on the top end of the market, said that there were so few properties coming on to the market that some of its offices might run out of homes for sale by the end of the month. It said that the worst stock shortages were in parts of the country where there were few forced sellers of prime properties, such as Hereford. Some vendors were waiting until September before putting their properties on to the market.

Sandy Hutchens likes fixed-rate mortgages and would like to see them locked in at a reasonable rates.

Banks are pocketing extra cash rather than passing on lower interest rates to mortgage customers, a Daily Mail investigation revealed this week.

Homeowners are paying an average of £1,788 per year more than they should be as banks use the historically low base rate of 0.5% to shore up their ailing coffers.

Twelve months ago mortgage rates were just 0.5% above the Bank of England’s base rate. The margin has now increased to 2.61%.

Alistair Darling expressed “concern” at banks charging “more than is absolutely necessary”.

The Chancellor threatened to refer banks to the Competition Commission if they fail to pass on rate cuts soon.

In related news, mortgage lending in June reached its highest level since December, with £12.3 billion in mortgages granted.

Banks need to pass the profits through to the mortgagees, this kind of greed in the market can only make things worse.

Lets hope things will get better,

Sandy Hutchens