New Ceiling

Buyers in high-priced markets get a hand

The Boston Globe
March 8, 2008 Saturday
THIRD EDITION

BYLINE: Kimberly Blanton Globe Staff
SECTION: BUSINESS; Pg. F1

The federal government yesterday increased the limit for government-backed mortgages, a move that could make home loans cheaper for several thousand Boston-area borrowers.

The limit increased to $523,750 for mortgages in the Boston metropolitan area that would qualify for government backing from Freddie Mac and Fannie Mae, which purchase the loans in the secondary market. The previous limit was $417,000.

Mortgages above the Freddie and Fannie ceiling are jumbo loans, and carry a higher interest rate. During the credit crisis last year, rates on jumbo loans surged to more than a percentage point above so-called conforming loans, or those under the federal loan limit.

Congress adopted a temporary increase in the loan ceiling in the economic stimulus package passed last month, in an attempt to energize the moribund housing market. Higher limits would make it cheaper for more borrowers in high-price housing markets such as Boston to buy a home or refinance an existing mortgage. The limits apply to mortgages originated between July 1, 2007 and the end of 2008.

"A great thing has happened," said Sushil Tuli, president of Leader Bank in Arlington. "It should help people become homeowners, because the payments will be lower with the lower interest rate."

Loans that fall between the old loan ceiling and the new ceiling will likely still carry higher interest rates than traditional conforming mortgages, because of the way Fannie Mae and Freddie Mac will be forced to handle them. Tuli said he and other bankers are still examining the new limits, but he estimated the interest rate for a 30-year, fixed-rate mortgage under the new limit would be about 6.125 percent, versus jumbo rates of 6.75 percent or higher.

If the limits had been in effect last year, about 4,000 additional refinance loans and 1,600 additional home-purchase loans in Greater Boston would have been categorized as conforming and eligible for federal support, according to Warren Group, a Boston property research firm. About 14,500 jumbo purchase and refinance loans were made in the metropolitan area in 2007.

"In more expensive housing markets like Boston, where there are more expensive homes and large mortgage requirements, the raising of the conforming ceiling is going to have a bigger impact than it is in less expensive housing markets," said Alan Pasnik, Warren Group's analyst.

The $523,750 limit will apply to single-family mortgages in the Boston area, which includes Essex, Middlesex, Norfolk, Plymouth, and Suffolk counties. Elsewhere in Massachusetts, the federal government said the new loan limits were $462,500 for the Barnstable area; $475,000 for the New Bedford and Providence area; and $729,750 for Nantucket and Martha's Vineyard.

Stephen Cochran, a loan officer for Poli Mortgage Group in Norwood, said people have been inquiring in recent weeks about the change. "It's creating a lot of excitement out there," he said.

Aftershock Rocks Credit Markets

Heightened concern about credit risk seeps further into segments of financial markets once thought safe

Investment Dealers Digest

March 17, 2008

BYLINE: Aleksandrs Rozens

If last August's credit problems were a high-powered quake, then the latest problems on Wall Street are its aftershocks. And while aftershocks may be expected, their intensity can be surprising. Such was the case in the early days of March.

While a broad range of securities saw a widening in yield premiums, investors were stunned by a rapid widening in spreads of bonds backed by home loans with Fannie Mae and Freddie Mac guarantees, securities seen as so pristine that they are purchased by foreign central banks and routinely used as collateral for loan agreements primary dealers have with the Federal Reserve.

Yield premiums for these housing agency mortgage securities were driven wider by well-publicized problems at a leading mortgage company as well as reports of margin calls faced by several notable hedge funds.

"The number of funds impacted and the securities impacted have grown," says Jeffrey Rosenberg, head of credit research at Bank of America. "As that credit unwind has occurred you are squeezing out leverage from more corners of the financial markets."

The widening of agency mortgage bonds early this month eclipsed what was seen in the wake of the 1998 Long Term Capital Management debacle and served as a reminder that credit woes in the financial markets are by no means over. The concerns about credit showed up in the credit default swaps market where it cost more to insure bank debt and interest rate swaps which are considered a barometer of credit conditions. In early March, the US central bank had to flood liquidity into the financial system through two separate actions.

"The spikes in volatility and price action are unfathomable," says the head of sales at one dealer firm's mortgage backed securities desk. "This is scary. Most people are shell-shocked," says the veteran of Wall Street who for over two decades has traded and sold mortgage bonds.

Jumpy credit markets

To get an idea of just how jumpy Wall Street has gotten when it comes to credit risk, investors ought to look at that gauge of credit conditions and economic well-being, interest rate swaps.

Ten-year interest rate swaps were at 87 basis points last week, having hit 91 in the first week of March. That is just shy of the autumn of 1998, when they were at 96-1/2.

Within the credit default swaps market, where investors purchase insurance against default, yield premiums, too, have widened. For example, Citigroup five-year credit default swaps were at 220 basis points, out from 10 to 20 basis points a year ago, while Bear Stearns five-year credit default swap spreads were at 510 basis points, out from roughly 35 basis points a year ago. JPMorgan spreads were at 150 basis points, out from 12 to 15 basis points a year ago.

Washington Mutual, a well-known participant in the mortgage market, saw its five-year credit default swaps move out to as much as 750 basis points. A year ago, insurance for five-year Wamu debt was at around 45 basis points.

Some of that widening in Wamu, no doubt, was tied to a recent downgrade in the thrift's credit rating by Standard & Poor's which warned of a "more severe residential mortgage credit cycle" and predicted that the severity of losses on all residential mortgages will be higher than initially expected.

Carlyle and Thornburg

When it comes to agency mortgage bonds, much of the widening was spurred by selling related to hedge funds having to meet margin call requirements.

"As mortgages got worse, people got more margin calls," says Art Frank, head of mortgage research at Deutsche Bank. "News of Carlyle and Thornburg prompted people to sell," says Deutsche Bank's Frank.

Among those facing margin calls was Carlyle Capital Corp., an affiliate of The Carlyle Group. Last week, Carlyle Capital was in discussions with lenders that held $16 billion of its securities, but these talks failed and on Wednesday the fund manager said lenders may seize its assets. According to Carlyle Capital's December 2007 annual report, the fund manager held $21.7 billion of residential mortgage-backed bonds, financed through $21 billion of one-month repurchase agreements with commercial and investment banks.

At the same time, financial markets have been surprised by problems encountered at Thornburg Mortgage. The 15-year old Santa Fe, N.M.-based lender specializes in jumbo loans that, by many accounts have performed well amid the nation's housing downturn. Thornburgh restated its financial statements for the year ended December 2007.

The mortgage lender said in filings with regulators that its board "decided that [Thornburg] should restate these financial statements after concluding that there was substantial doubt as to [its] ability to continue as a going concern."

As a result, Thornburgh warned, losses on its available-for-sale securities and securitized adjustable rate mortgage (ARM) loans pledged as collateral for repurchase agreements "were considered to be other-than-temporary impairments as of Dec. 31, 2007 since [Thornburg] may not be able to hold these securities for the foreseeable future because [it] may sell them to satisfy margin calls from [its] lenders or to otherwise manage [its] liquidity position."

In these same documents, the lender explained how last summer until recently the fair value of its ARMs as well as its hedges declined so margin requirements on its financing agreements increased.

In March, Thornburg said, "we have received a significant amount of margin calls ... which significantly exceeded [its] available liquidity ... as a result, [Thornburg has] been unable to meet a portion of our margin calls."

Thornburg also warned that while it has a temporary agreement with lenders halting additional margin calls through March 10, there was no assurance it will be able to get enough liquidity to satisfy its liabilities or that the value of its ARM loans or bonds pooling ARMs do not decline further.

Also, Thornburg said it could not assure lenders won't make additional margin calls or that the Sante Fe, N.M., company will be able to satisfy these margin calls and "continue as a going concern."

Margin Cascade

The latest worries in the US credit markets - to the surprise of many on Wall Street - come from an unusual source: bonds backed by home loans with Freddie Mac and Fannie Mae guarantees.

While these mortgages have seen an increase in the late payments and defaults, they are nowhere as bad as subprime home loans.

In February, many investors - including hedge funds - saw that mortgage bonds guaranteed by the housing agencies had seen their yield premiums widen to levels not seen in 15 years. Viewing the market as oversold, investors sold their US Treasury holdings and dove into the agency mortgage bonds.

What happened next, shocked even old hands in the US housing finance world. Agency mortgage bond spreads hit levels not seen since 1986 when the nascent mortgage bond market was buffeted by its first wave of home loan refinancings.

As the spreads widened and hit that 1986 level, lenders asked investors to make up for the difference in the value of securities used as collateral for the loans. This forced some investors to sell their most liquid securities, in this case the agency mortgage bonds. In some cases, lenders seized the collateral and put it out in the market.

For those who relied on leverage to amplify returns, the rapid widening in agency mortgage bonds came as a shock and brought about a cascade of margin calls.

"As you move to execute on your right to claim collateral you can exacerbate losses," says Bank of America's Rosenberg, adding that "you are reducing liquidity in the market."

"As more mortgages performed worse, people were more likely to get margin calls," says Deutsche Bank's Frank.

The selling also spurred sales by money managers and banks who wanted to get ahead of any further widening in agency mortgage bond spreads. At the same time, there were no notable buyers of agency mortgage securities even though they were broadly seen as oversold and even inexpensive.

"There was someone selling every minute every day," says Chris Low, chief economist at FTN Financial.

In 1998, a widening in mortgage bonds guaranteed by Freddie Mac and Fannie Mae in the wake of Long Term Capital Management's problems brought about buying by the two housing agencies. This time around, Fannie Mae and Freddie Mac have limits as to how much they can buy for their portfolio and they themselves face a jump in losses related to late payments as well as defaults for loans they have guaranteed. Also, agency borrowing costs have risen because investors are demanding more of a yield premium to buy their debt. For example, five-year credit default swaps insuring senior agency debt are at 91 to 92 basis points and 200 to 210 basis points for subordinate agency debt.

"There is no risk appetite," is how the veteran bond salesman with the Wall Street dealer firm characterized the current market. "People are worried about career risk. They can't be long" mortgages, he adds.

Just how much wider are US agency mortgage security yield premiums?

The interpolated current coupon agency mortgage bond in early March was at 190 basis points to seven-year swaps and it was 293 basis points over interpolated US Treasuries. "This is the widest mortgages have been since the summer of 1986," says Deutsche Bank's Frank.

Back then, the mortgage market was smaller. Today, the mortgage bond market is the largest credit market in the word. In 1986 the widening came after large influx of mortgage securities on the heels of a massive refinancing wave of home loans. The wider spreads prompted Wall Street to expand the structured mortgage bond market by repackaging simple agency mortgage pass throughs into bonds known as planned amortization class securities or PACs.

These days, the mortgage bond mart has seen little of this structured mortgage debt created.

In February, $19.5 billion of collateralized mortgage obligations were created. While that is up from January's $6.6 billion and December's $5.9 billion, it is off from $34.7 billion worth of CMOs created last June.

Although the widening was surely tied to massive sales by hedge funds and other investors, there is another reason behind the wariness about mortgage debt. What was once merely a problem within subprime debt is now a problem within Alt-A home loans and has crept into the prime market. Recent data from an industry trade group showed that fourth-quarter foreclosures for a wide range of home loans were at historic highs and delinquencies were at a pace not seen since the mid 1980s.

What next?

Early last week, the Fed came in again to support liquidity in financial market. Specifically, the US central bank expanded its securities lending program to include agency debt, agency mortgage bonds and AAA-rated residential mortgage bonds with loans that did not have the agency guarantee.

Also, the Fed increased temporary reciprocal currency arrangements with the European Central Bank and the Swiss National Bank. Financial markets saw prices of stocks soar higher with approval.

That said, credit on Wall Street remains tight. Lenders are asking for larger haircuts in repo agreements, meaning borrowers will have to post more collateral for less money.

"The cost of borrowing has risen and availability has gone down," says Bank of America's Rosenberg. "The increase in required margins have gone up significantly. The reason why is the perceived volatility of all assets used for collateral has gone up."

Meanwhile, spreads for many securities ranging from high yield corporate debt to commercial mortgage bonds have seen their yield premiums widen. Within the leverage loan market, paper that changed hands in January at 95 cents now trades at 88 cents. Last August when the subprime turmoil was first felt, these leverage loans could command a price of 95 cents.

An index of tracking home equity debt underwritten in 2006, the HEL ABX 06-2AA tranche, that is widely used on Wall Street to value securities is trading at 30 cents to the dollar. A year ago, these issues were at or close to par.

Just how much more does it cost for hedge funds to borrow? That depends on the securities being posted as collateral. But in the case of adjustable rate mortgage debt or collateralized mortgage obligations with loans guaranteed by Freddie and Fannie the cost has risen by 30 to 40 basis points.

"Usually you could borrow at Libor. Now it is at Libor plus 40 [basis points]," according to Andreas Pericli, chief executive officer of Wash., DC-based hedge fund Euclid Financial Group. "They need more collateral and they lend less."

Soon after the Fed action early last week, FTN's Low predicted that the central bank's move "should put a floor under prices."

Pericli agreed: "The Fed action will help significantly over time."

Deutsche Bank's Frank noted that last Tuesday's Fed action helped improve the tone to the US mortgage market. He said that the most actively traded mortgage bonds were nearly 20 basis points tighter at 171 basis points to swaps.

Rosenberg meanwhile was more reserved with his optimism. "The issues are not immediately solvable by the Fed. The can alleviate the credit crunch, but it takes time for policy levers to work through."

Joyce Delucca, managing principal at Kingsland Capital, was also circumspect.

"It is great to see that the stock market traded up (on news of the Fed move), but I don't think it fixes the problem. It does improve liquidity for banks and broker-dealers, but whether or not that liquidity reaches the broader system remains to be seen."

TOP OFFICIALS SEE BLEAKER OUTLOOK FOR THE ECONOMY

BYLINE: By EDMUND L. ANDREWS
The New York Times

February 15, 2008 Friday
Late Edition - Final

SECTION: Section A; Column 0; Business/Financial Desk; Pg. 1

With the credit markets once again deteriorating, the nation's two top economic policy makers acknowledged Thursday that the outlook for the economy had worsened, as both came under criticism for being overtaken by events and failing to act boldly enough.

In testimony to Congress, Ben S. Bernanke, the chairman of the Federal Reserve, signaled that the Fed was ready to reduce interest rates yet again, pointing out that problems in housing and mortgage-related markets had spread more widely and proved more intractable than he predicted three months ago.

His sobering assessment was echoed by Treasury Secretary Henry M. Paulson Jr., who appeared with him. Both continued to avoid predicting a recession but said they were scaling back the more optimistic forecasts they had issued in November.

Ethan S. Harris, chief United States economist for Lehman Brothers, said that both policy makers had ''come clean'' about the economy's problems but that investors were not impressed.

Stock prices, which normally rally when the Fed hints it will lower borrowing costs, tumbled instead. The Dow Jones industrial average dropped 175 points, or 1.4 percent; broader stock indexes dropped by similar amounts.

Anxiety is escalating among institutional lenders and major borrowers, as the panic over soaring default rates on subprime mortgages that began last summer continues to spread, freezing up credit for municipalities, hospitals, student loans and even investment funds holding the most conservative bonds.

On Capitol Hill, the economic policy makers found themselves in the line of fire. Senator Robert Menendez, Democrat of New Jersey, accused both Mr. Bernanke and Mr. Paulson of having ''hit the snooze button.''

Senator Christopher J. Dodd of Connecticut, chairman of the Banking Committee, told reporters after the hearing that ''it just seems as if they aren't as concerned about the magnitude of the problem.''

Testifying before the committee, Mr. Bernanke said he still expected the economy to grow at a ''sluggish'' pace over the next few months and to pick up speed later in the year. But he said ''the downside risks to growth have increased,'' noting that spiraling losses in home mortgages have dragged down the credit markets and shaken the broader economy.

While trying to be optimistic, Mr. Paulson said that the administration's forecast ''would be less, but I do believe we'll keep growing.''

Many Wall Street economic forecasters, however, are already estimating that the risks of a recession are at least 50-50, and a growing number of analysts contend that an economic contraction may have already begun.

Fed policy makers will release their newest forecasts on Wednesday, and Mr. Bernanke said they would be more in line with those of private-sector economists.

The Fed has reduced its benchmark interest rate, called the federal funds rate, five times since September, including two cuts within eight days last month. The rate has fallen to 3 percent; as recently as late summer of last year it was 5.25 percent.

Mr. Bernanke assured lawmakers that the Fed would ''provide adequate insurance'' against a downturn in the form of cheaper money.

But neither investors nor politicians have responded particularly favorably to Washington's moves. Yields on asset-backed securities that hold mortgages and other debt have risen to levels almost as high as they were last August, when financial markets first seized up in response to soaring default rates on subprime mortgages.

The Fed's rate cuts have led to a more modest decline in mortgage rates for borrowers with good credit, but they have done little to ease the broader credit squeeze.

Mr. Bernanke agreed that banks and other lenders have been pulling back, both because of increased aversion to risk and because they have been forced to book huge losses from soured loans and to repurchase troubled mortgages and loans they had sold to investors.

The unexpected losses and growing pressures, he continued, have prompted banks to become more restrictive in their lending and more ''protective of their liquidity.''

Mr. Bernanke said the economy would grow slowly but pick up speed later in response to both the Fed's lower interest rates and the $168 billion economic stimulus package that President Bush signed Wednesday.

''At present, my baseline outlook involves a period of sluggish growth, followed by a somewhat stronger pace of growth starting later this year,'' he told lawmakers. But in cautioning that his outlook could turn out to be wrong, the Fed chairman left the door open to additional rate reductions.

Mr. Paulson tried to sound less downbeat. ''I believe we are going to continue to grow, albeit at a slower rate,'' he told the Banking Committee, insisting that the plunge in housing and credit markets was a correction rather than a crisis.

Mr. Bernanke said a wide variety of economic indicators had declined in recent months, as the meltdown in the housing and mortgage markets rippled through the broader economy.

The Fed chairman said the job market had worsened, noting employment fell by 17,000 jobs in January, according to the Labor Department. That was down from an average rise of 95,000 jobs a month in the final three months of 2007. Unemployment, though still comparatively low, at 4.9 percent, has edged up from 4.7 percent a few months ago.

Nationwide, housing prices have declined and show no signs of having hit bottom, while the stock markets have fallen sharply from their highs late last year.

Mr. Dodd has proposed legislation to create an agency to bail out many homeowners by buying up and restructuring troubled mortgages. He painted a particularly bleak picture.

''The current economic situation is more than merely a 'slowdown' or a 'downturn,' '' he said. ''It is a crisis of confidence among consumers and investors.''

Mr. Paulson and other administration officials staunchly oppose a government buyout program, arguing that the tax rebates and business tax cuts in the new stimulus package should keep the nation out of a recession.

But Senator Richard C. Shelby of Alabama, ranking Republican on the Banking Committee, predicted the bill's tax rebates and temporary tax cuts for business would have a negligible impact.

''I have equated it to pouring a glass of water in the ocean and expecting it to make a difference,'' Mr. Shelby said.

Though lawmakers welcomed the Fed's willingness to lower interest rates, investors had already been assuming that events would force the Fed's hand.

Prices in the federal funds futures market, which allows investors to bet on the coming course of rates, indicate investors expect the central bank to reduce its benchmark overnight rate another full percentage point, to 2 percent, by the end of June.