Fighting U.S. on Housing Hazardous in Gundlach View: Mortgages
January 30, 2012, 6:23 PM ESTBy Sree Vidya Bhaktavatsalam and Jody Shenn
Jan. 26 (Bloomberg) -- DoubleLine Capital LP’s Jeffrey Gundlach, manager of the top performing mortgage fund last year, is shunning “overpriced” Ginnie Mae securities, because investors underestimate the risk that the Federal Reserve and President Barack Obama will spur a homeowner refinancing wave.
“I’m astonished people are fighting the will of the U.S. government,” Gundlach, founder and chief investment officer of Los Angeles-based DoubleLine, said in a telephone interview. “Investors are being insufficiently compensated,” especially given the risk of higher prepayments.
Ginnie Mae bonds are trading 2.5 cents on the dollar higher than Fannie Mae debt, more than double the difference over the past five years, making them more susceptible to price declines, according to data compiled by Bloomberg. Fed Chairman Ben S. Bernanke is attempting to accelerate refinancing by holding short-term interest rates near zero, buying mortgage bonds and advocating for changes to government housing policy. Obama said this week he plans to send legislation to Congress to help more homeowners take advantage of record-low borrowing costs.
Government-backed mortgage bonds trading at more than face value because of their relatively high coupons can be damaged when borrowers repay their debt more quickly, because it hands investors their money back at par. That’s the biggest risk in the $5.4 trillion market, including for Ginnie Mae’s, said Gundlach, whose $17 billion DoubleLine Total Return Bond Fund rose 9.5 percent in 2011 to beat all of its peers.
Ginnie Mae prices average more than 109.5 cents on the dollar, according to Bank of America Merrill Lynch index data.
‘Locked Out’
DoubleLine, which oversees $24 billion, has bought “locked-out” slices of so-called collateralized mortgage obligations that protect investors from that possibility, he said. That’s allowed the fund to reduce exposure to prepayments by more than 50 percent in the past six months, Gundlach said.
Ginnie Mae, which is based in Washington and formally named the Government National Mortgage Association, was created in 1968 as a U.S. government-owned corporation and issued the first mortgage-backed security two years later. Loans insured by the Federal Housing Administration, which allow down payments of as low as 3.5 percent for home purchases, account for most of the mortgages in its $1.2 trillion of bonds.
Fannie Mae and Freddie Mac, the mortgage-finance companies that have been supported by the U.S. since being seized in 2008, guarantee $4.3 trillion of home-loan debt. Obama’s administration had the two companies revise the federal Home Affordable Refinance Program for their loans with little or no home equity to stoke refinancing starting last month. By contrast, the FHA has added to the costs of refinancing into lower rates.
Prevented Borrowers
The agency boosted its annual premiums in two steps starting in October 2010, to as much as 1.15 percent from 0.55 percent. Since 2009, the FHA has also prevented its existing borrowers from rolling closing costs for refinancings into their new loans unless they can re-qualify with new appraisals. It also began requiring lenders to determine that borrowers will cut payments by at least 5 percent, switch to a fixed-rate or shorten their terms to qualify for its streamlined program, as well as excluding borrowers with recent delinquencies.
The administration hasn’t yet detailed the expanded refinancing push that Obama mentioned in his State of the Union speech this week, though the president said it would require legislation. Lemar Wooley, an FHA spokesman, declined to comment.
Prepayment Differences
Prepayments on Ginnie Mae’s 4.5 percent, 30-year mortgage securities last month came at a pace that would erase 17.3 percent of the debt in a year, compared with 26.2 percent for similar Fannie Mae debt. The underlying loans’ rates average about 5 percent.
The price gap between the Ginnie Mae and Fannie Mae bonds has narrowed from a record 3.1 cents in November to 2.5 cents as of Jan. 25, Bloomberg data show.
While the debt is less overvalued than last year, investors “need to rotate out of them,” said Gundlach, who was previously the chief investment officer of TCW Group Inc. in Los Angeles until starting DoubleLine Capital in December 2009.
The DoubleLine Total Return fund was the top-performing among 63 mutual funds that invest in mortgage-related securities, according to data compiled by Bloomberg. The $1.6 billion Columbia U.S. Government Mortgage Fund was the second- best performer last year, rising 8.9 percent, while Pacific Investment Management Co.’s $2 billion Pimco GNMA Fund was third, with an 8.4 percent gain, Bloomberg data show.
DoubleLine Holdings
The DoubleLine fund has 48 percent of its assets in agency- backed mortgage debt, with 2 percent of that invested in Ginnie Mae bonds, said Gundlach. Prices on those securities would have to drop by 1.25 percentage points to be attractive, he said.
Buyers of Ginnie Mae bonds are primarily concerned that they offer more attractive yields than Treasuries rather than how they trade relative to Fannie Mae securities, Nomura International analysts including Ohmsatya Ravi and Ankur Mehta wrote in their 2012 outlook last month. That’s why they’ll keep acquiring, the analysts wrote.
Ginnie Mae securities are explicitly backed by the U.S. While the government has vowed to protect holders of Fannie Mae and Freddie Mac bonds, it doesn’t officially guarantee their debt, which partly explains their lower prices, said Siddarth Ramkumar, a Barclays Capital mortgage strategist in New York.
“Certain overseas investors place a great emphasis on the explicit government guarantee,” he said.
Comparable Returns
Ginnie Mae securities returned 7.8 percent last year, the best performance since 2002, according to Bank of America Merrill Lynch index data. Government-supported U.S. mortgage bonds gained 6.1 percent overall and global corporate bonds advanced 5.2 percent.
Lenders including Bank of America Corp. are also favoring Ginnie Mae bonds as they plan for increased capital standards under Basel III, in addition to proposed rules under the international accord demanding they hold specific amounts of liquid assets. Ginnie Mae debt is treated better in both.
The gap between Ginnie Mae and Fannie Mae prices narrowed after the Fed said in December that the securities may both be treated the same under U.S. rules on banks’ holdings of liquid assets resulting from the Dodd-Frank financial overhaul.
BNP Paribas SA analysts led by Anish Lohokare wrote in a Jan. 12 report that investors may be “unjustified” in assuming based on the Fed’s proposal that it won’t later implement the Basel III liquidity rules in a way that penalizes Fannie Mae and Freddie Mac debt.
Bernanke Reinvests
The gap between Ginnie Mae and other agency debt may narrow this year as Bernanke reinvests proceeds from mortgage bonds the Fed has bought since January 2009.
“The bonds could weaken versus conventional agencies going forward as the Fed reinvests into Fannie Mae and Freddie Mac securities,” said Ramkumar.
One recent measure suggests Ginnie Mae prepayments will rise. A Mortgage Bankers Association index measuring refinancing applications for FHA mortgages and other loans directly insured by the U.S. has climbed about 60 percent since mid-December while the group’s benchmark for conventional debt gained 30 percent, Credit Suisse Group AG analysts led by Mahesh Swaminathan said yesterday in a report.
The “magnitude of the increase in the government refi index is surprising with no satisfactory explanation,” the analysts wrote. The disparity though between the two measures does suggest a jump in Ginnie Mae prepayments in coming months.
While Gundlach said he wasn’t sure the government can pull off a mass refinancing, current prices don’t compensate investors enough.
“The announcements by President Obama and Ben Bernanke in a 24-hour period were a one-two punch,” Gundlach said. “They want people to refi.”
--With assistance from in New York. Editors: Pierre Paulden, Rob Urban
To contact the reporters on this story: Sree Vidya Bhaktavatsalam in Boston at sbhaktavatsa@bloomberg.net Jody Shenn in New York at jshenn@bloomberg.net;
To contact the editor responsible for this story: Rob Urban at robprag@bloomberg.net
