By Darrell Hassler
Dec. 1 (Bloomberg) -- The mortgage bond market is beginning to buckle under the weight of the worst U.S. housing slump in six years.
Yields on so-called sub-prime mortgage securities rated BBB have risen to 6.52 percent on average from 6.28 percent on Sept. 5, data compiled by Bank of America Corp. show. The yield premium, or spread above the one-month London interbank offered rate, a lending benchmark, rose to a seven-month high of 1.2 percentage points.
About 3.3 percent of the $160 billion in sub-prime loans made this year through July have payments that are more than two months late, the highest ever for mortgages in their first year, according to New York-based Fitch Ratings. Housing starts tumbled in October to an annual rate of 1.486 million, the lowest in more than six years. The economy grew at the slowest pace since 2005 during the third quarter.
``The higher delinquencies do set off an alarm for many people and make us more conservative,'' said Alex Wei, a senior vice president at Delaware Investments in Philadelphia.
Delaware Investments, which has about $100 billion in bonds including mortgages, is buying more asset-backed bonds with top credit ratings such as AAA and less of those rated BBB, which are more sensitive to delinquencies and defaults, Wei said. The higher-rated bonds yield about 1.1 percentage points less than BBB debt.
Housing Slump
Most sub-prime mortgages -- to borrowers with poor or limited credit histories, or with higher-than-average debt levels -- pay fixed rates for the first two to three years and then adjust to market rates. They made up 19 percent of all U.S. mortgages in the first half of 2006, according to the Washington- based Mortgage Bankers Association.
When the housing market was setting records in sales and prices last year, securities backed by floating-rate sub-prime mortgages returned 3.9 percent including reinvested interest, almost double the 1.97 percent gain for investment-grade corporate bonds, according to data compiled by Merrill Lynch & Co. Bonds rated BBB- and above at Standard & Poor's and at least Baa3 at Moody's Investors Service are investment grade.
The median price of a new home fell by 9.7 percent in September, the biggest drop since 1970, government reports showed. The decline was one reason why the economy slowed to a 2.2 percent annual growth rate in the third quarter from 2.6 percent in the prior three-month period, the Commerce Department in Washington said Oct. 27. The median home price rose 1.9 percent in October.
Interest Costs
Sub-prime mortgage securities have returned 1.38 percent in the past three months, less than half the 3.63 percent return for corporate debt. The difference between yields on the mortgage bonds and Libor widened 0.25 percentage point in the past three months while the gap for similarly rated corporate debt narrowed 0.05 percentage point. Prime mortgages have returned 2.78 percent.
Sub-prime lenders New Century Financial Corp. of Irvine, California, Accredited Home Lenders Holding Co. in San Diego and Columbia, Maryland-based Fieldstone Investment Corp. are paying more in interest on the bonds they sell to fund mortgages.
Interest expense for New Century rose 29 percent to $375 million in the third quarter from a year earlier. Accredited's jumped 62 percent to $138 million. Fieldstone's payments climbed by 57 percent to $91 million.
Less Stringent
Late payments are accelerating after lenders began to require less documentation for loans and financed more homes without down payments, New York-based Bear Stearns & Co. analyst Gyan Sinha said in a Nov. 14 report.
About 38 percent of the most common sub-prime mortgages this year were for the full value of the home, up from 31 percent in 2005 and 21 percent in 2004, according to Bear Stearns. Sinha said 45.5 percent of the loans this year required ``low documentation'' of borrower income and net worth, up from 44.5 percent in 2005 and 40.1 percent in 2004.
The data reflect ``common methods of allowing first-time homebuyers to borrow more than they can afford,'' Sinha said.
There are signs housing may be bottoming, as sales of new homes rose in August and September before dropping in October. Confidence among U.S. homebuilders increased last month, the second straight gain, a private survey showed on Nov. 16.
Bill Gates, the world's richest person, bought shares of seven U.S. homebuilders through his philanthropic organization, a regulatory filing showed on Nov. 15. Homebuilder shares are up 15 percent on average since July after falling 30 percent in the first half of the year, according to the Standard & Poor's Supercomposite Homebuilding Index.
Higher-rated sub-prime bonds are still in demand, suggesting investors are confident that banks will tighten their lending practices and strengthen the collateral backing the securities, Wei of Delaware Investments said.
Yield Premium
The yield premium on AAA rated securities has stayed at about 5 basis points over Libor the past three months, Bank of America data show. The 5.07 percent total return on all sub-prime mortgage securities this year is better than each of the last six years, according to Merrill Lynch data.
Lower-rated bonds are at a greater risk, according to Moody's and Fitch Ratings.
Moody's on Nov. 14 said it may cut the ratings on $7.16 million of debt rated Ba2 sold by Anaheim, California-based Fremont Investment & Loan.
Fitch is considering whether to put ``a few'' sub-prime issues on review for a possible ratings cut, Managing Director Grant Bailey in New York said in a Nov. 20 interview.
``There's no doubt that there is going to be some increased credit risk,'' Bailey said. He declined to be more specific.
To contact the reporter on this story: Darrell Hassler in Chicago at dhassler@bloomberg.net .
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