Bloomberg News

Pimco Says Mortgage Bonds Cheap After Slump on Obama Plan

October 25, 2011

(Updates with Goodman comments in 10th paragraph.)

Oct. 25 (Bloomberg) -- Pacific Investment Management Co. says investors should buy Fannie Mae and Freddie Mac mortgage- backed securities that slumped in response to planned changes to the government-supported companies’ refinancing rules.

“If you didn’t sell them two months ago and you’re selling them today, you deserve to be fired,” Scott Simon, the mortgage head at Newport Beach, California-based Pimco, which runs the world’s largest bond fund, said today in a telephone interview.

The money manager joined analysts at Amherst Securities Group LP and BNP Paribas SA in saying the consequences of an expansion to the Home Affordable Refinance Program announced yesterday may be less damaging than some investors anticipate. The market has slumped as investors braced for a wave of refinancing amid President Barack Obama’s bid to stoke the economy by helping more homeowners cut loan payments.

Fannie Mae’s 6 percent 30-year fixed-rate securities declined by almost 0.7 cent on the dollar yesterday to about 109 cents, underperforming Treasuries by the most in 20 months, after the Federal Housing Finance Agency outlined the changes to the HARP program for loans guaranteed by the company or Freddie Mac to borrowers with little or no home equity.

Mortgage Holdings Boost

The debt, which reached almost 111 cents on Sept. 1, climbed to 109.2 cents as of 11:28 a.m. in New York today, outperforming U.S. government notes, according to data compiled by Bloomberg. Interest rates on the underlying mortgages average about 6.5 percent, compared with the average rate on new home loans of about 4.2 percent, according to Bankrate.com data.

Pimco boosted mortgage securities to 38 percent of assets in its $242 billion Total Return Fund in September, the most since January, from 32 percent the prior month, according to data on the firm’s website. Simon declined to say how much of the increase was tied to government-backed agency mortgage securities or other securitized debt.

The biggest surprise in yesterday’s announcement was that the FHFA said that Fannie Mae and Freddie Mac will waive their rights to demand refunds from lenders after flawed loan underwriting in many cases, according to analysts at Amherst, Credit Suisse Group AG and Barclays Capital.

There were “also surprises the other way,” as the FHFA, which is managing the conservatorships of Fannie Mae and Freddie Mac, failed to take steps as dramatic as expected on some issues and tightened certain refinancing rules, Pimco’s Simon said.

Short-Term Debt

The regulator said the companies would only waive the upfront fees they charge on riskier loans if borrowers take on short-term debt, an unattractive move for homeowners because of the higher monthly costs, he said. Officials also said borrowers with loan-to-value ratios of less than 80 percent no longer can use HARP, after accounting for 60 percent of volumes, he said.

Prices of “higher coupon mortgages already fully (or maybe more than fully) reflect” the likely increase in prepayment speeds as a result of the adjustments, Amherst analyst Laurie Goodman said in a report after trading ended yesterday.

Changes to lenders’ contractual promises to buy back debt after underwriting mistakes, called representations and warranties, appear limited, with the types of waivers being “very close to those Fannie Mae currently offers” already on HARP loans, Goodman wrote.

Repurchase Risks

The risk of mortgage repurchases for borrowers’ existing loans is being “substantially eliminated,” a move that represents “a very large bank-friendly set of changes” that will end up “doing little to encourage” lenders to refinance loans being serviced by other companies, she said.

A different lender will still need to make a broader set of representations for the new loan than its current servicer, limiting that company’s desire to originate it, Goodman wrote. Her comments contrast with ones yesterday by Housing and Urban Development Secretary Shaun Donovan.

Eliminating the representations and warranties on the existing loans “is something that will dramatically increase the incentives for other lenders to come in and compete to refinance these loans which can also help in driving down the costs,” Donovan told reporters on a conference call.

Anish Lohokare, an analyst at BNP Paribas, wrote in a note to clients yesterday that investors will find the changes “less threatening” as details emerge on issues ranging from borrowers’ ability to transfer mortgage insurance to originators’ representations and warranties. Further details will be announced by Nov. 15, the FHFA said in a statement.

--Editors: John Parry, Pierre Paulden

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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