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Easy Money’s Profit Rescuing U.S. Housing Diminishing

JAN 7, 2013 10:31am ET
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The era of increasingly cheap money that fueled the housing recovery and record home-lending profits is showing signs of ending in the mortgage bond market.

Fannie Mae-guaranteed 3% securities, which lenders use to price new loans, tumbled last week to the lowest since Sept. 12, the day before the Federal Reserve announced plans to add $40 billion of mortgage debt to its balance sheet each month. The drop, as lawmakers struck a budget deal and the central bank signaled it may conclude the open-ended bond-buying program this year, could lead to further increases in homeowner borrowing costs from the record lows set in December.

“It would present a test for the housing market just as we’re going into the key spring selling season,” said Mark Vitner, a senior economist in Charlotte, N.C., at Wells Fargo & Co., the top U.S. mortgage lender. “I wouldn’t wind it down when it is poised to do its most good.”

While no one expects mortgage rates to skyrocket, higher rates could challenge the rebound in U.S. residential real estate after a five-year slump by cutting how much homebuyers can afford to pay. Rising borrowing costs may also “spoil the party” for lenders that profited from a more than 20 percent jump in mortgage originations last year, according to Deutsche Bank AG, by slowing refinancing that’s benefited firms led by Wells Fargo and JPMorgan Chase & Co.

Bond investors should also anticipate reduced returns, according to Pacific Investment Management Co. Bill Gross, manager of the world’s biggest bond fund said in a Jan. 4 interview on Bloomberg Television that bets on mortgage securities “are over in terms of the capital appreciation.”

Banks and savings institutions posted $25.3 billion in mortgage-banking profit through the first nine months of 2012, or 24% of their $106.8 billion total earnings, according to data compiled by Bloomberg and the Federal Deposit Insurance Corp.

Lenders’ fattened margins appear to be already contracting as they seek to maintain volumes by absorbing some of the costs of lower bond prices rather than passing them on to borrowers, according to broker Brean Capital LLC.

Government-backed mortgage securities slumped last week as U.S. lawmakers on Jan. 1 agreed to a budget plan that averted the so-called fiscal cliff, which would have meant more than $600 billion of spending cuts and tax increases. The deal reduced tax hikes that could hurt economic growth while maintaining spending that boosts the supply of Treasuries. Bonds could slump again if Congress fails to cut “material expenses” as it continues to address the deficit, Deutsche Bank analyst Steve Abrahams wrote in a Jan. 3 report.

Bond market losses accelerated after the minutes of a December meeting of Fed policy makers released Jan. 3 showed several of them saw its $85 billion in monthly bond purchases as likely to end sometime in 2013, with some divided between a mid- or end-of-year finish.

The Fed had said after its Dec. 11-12 meeting it would hold its separate target for short-term borrowing costs near zero “at least as long” as the unemployment rate remains above 6.5% and inflation projections are for no more than 2.5 percent.

The dissension on the outlook for the debt purchases “spooked” investors, said Jason Callan, head of structured products at Minneapolis-based Columbia Management Investment Advisers LLC.

“Markets, being prescient, are going to try to get ahead of” the end of the Fed’s mortgage bond buying, said Callan, whose firm manages $165 billion of fixed-income assets. “I personally don’t think the rise in yields is all that sustainable in the short-term,” but it would be a “pretty distinct negative for the sustainability of the housing recovery,” he said.

Fannie Mae’s 3 % mortgage bonds fell to as low as 103.7 cents on the dollar on Jan. 4, from 104.9 cents on Dec. 28, driving yields up to 2.02% as the prices ended last week at 104.2 cents, according to data compiled by Bloomberg.

“The real kick that you mentioned in 2012 is over as perhaps is the real kick in corporate bonds,” Gross said on Bloomberg Television. “The total return from bond portfolios in 2013 to our way of thinking is a 3% to 4% number, it’s not a 10% to 11% number.”

Yields in the $5.2 trillion market for government-backed mortgage securities influence rates offered to consumers because lenders package about 90% of new loans into the bonds and then sell off the debt to investors.

The average cost on 30-year fixed-rate mortgages climbed to 3.48% as of Jan. 3, from a record low 3.36% on Dec. 7, according to Bankrate.com data.

Mortgage rates may rise above 4% by the end of 2013 if the Fed ends its bond purchases and the economy continues to strengthen, Vitner said. Increases could damp the still-fragile housing recovery, which has had false starts in the past, and slow the rebound in new home construction, which is the real estate market’s main contributor to economic growth, he said.

A borrower able to make monthly payments of about $1,310 can afford a $275,000 30-year loan with rates at 4%, versus $300,000 with borrowing costs at 3.3%.

Bond rates are climbing even as Republican leaders in the House are vowing to exact deep spending cuts from President Barack Obama and the Democrats in exchange for raising the debt ceiling as the U.S. Treasury bumps up against its legal borrowing limit. European countries including Spain and Italy also face fiscal pressures that roiled markets last year.

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