According to Fannie Mae and Freddie Mac, they plan on increasing purchases to help increase prepayments on securities to rates. The constant prepayment rate, or CPR, for Freddie Mac’s 30- year fixed-rate securities with 6.5 percent coupons will likely surge by 70 this month under the plan released yesterday by the McLean, Virginia-based company, based on Bloomberg calculations. The measure, which was 17.2 last month, represents the share of the debt that would be retired in a year at the current pace.

Freddie Mac said yesterday that it would buy “substantially all” loans with payments late by 120 days or more from its securities in the next month. Fannie Mae said later that it will “increase significantly” its buyouts, setting a less aggressive timeline. The value of Freddie Mac’s delinquent loans is $70 billion, while Fannie Mae has $130 billion of the debt, according to Citigroup Inc. data.

“This is going to be a wad of cash coming into the fixed- income markets and it’s not immediately clear where it’s going to be reinvested,” said Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee.

Fannie Mae’s 30-year fixed-rate 6.5 percent securities fell to 107.46 cents on the dollar yesterday, from a record 108.25 the previous day, the steepest drop since July 2008, data compiled by Bloomberg show. Freddie Mac’s securities logged similar losses and the full pain for investors is larger because the prices reflect contracts for settlement next month when many of the loans may have been repurchased, analysts including Citigroup’s Brett Rose wrote in notes to clients.

Today’s Decline

Fannie Mae’s securities fell further today, to 107.13 cents on the dollar as of 10 a.m. in New York, or 0.38 cents less than similar Freddie Mac securities, matching the largest difference in at least 20 years, reached last in 2007, Bloomberg data shows.

The difference between yields on Fannie Mae’s so-called current-coupon 30-year securities, which most directly influence rates on new home loans because they trade closest to par, and 10-year Treasuries narrowed today by 0.02 percentage point to 0.68 percentage point.

That’s down from 0.76 percentage point on Feb. 8, according to Bloomberg data, which uses a current-coupon index now based on 4 percent and 4.5 percent securities.

‘Tightening Effect’

The spread has expanded since the Federal Reserve’s buying of $1.25 trillion of home-loan securities helped drive the gap to 0.66 percentage point on Jan. 6, the tightest in more than 17 years. Investors may choose to buy these mortgage securities with the cash returned with prepayments on higher-coupon debt.

“If this cash is to be reinvested in mortgages, it could have a tightening effect,” New York-based analysts at Amherst Securities Group led by Laurie Goodman wrote in a report yesterday. “This will help cushion the effect of the end of the Fed purchase program.”

Investors who buy bonds for more than face value risk losses from the repurchases because they get fewer interest payments than they may have estimated. Fannie Mae and Freddie Mac would pay missed interest to bondholders if they didn’t repurchase the loans.

“Freddie dropped the buyout bombshell,” Brian Ye, an analyst at JPMorgan Chase & Co. in New York, said in a note to clients yesterday.

‘Operational Differences’

The companies’ policies vary in part because of “operational differences: Freddie can buy delinquent loans directly out of pool. Fannie has to ask the servicer to do so,” the Amherst analysts wrote. “Thus, the additional month delay is to allow servicers to gear up for this, and the few-month timeframe is meant to allow for servicer capacity constraints and other operational issues.”

Freddie Mac is also more prepared to fund its buyouts, based on its recent sales of corporate debt, analysts including FTN’s Vogel said.

The buyouts don’t imply any changes to how Washington-based Fannie Mae and Freddie Mac, which were seized by regulators in 2008, deal with troubled borrowers, including under the federal Making Home Affordable Program modification plan, the companies said. Instead, the purchases reflect a desire to reduce expenses, they said.

“The decision to effect these purchases stems from the fact that the cost of guarantee payments to security holders, including advances of interest at the security coupon rate, exceeds the cost of holding the nonperforming loans in the company’s mortgage-related investments portfolio,” Freddie Mac said.

Missed Interest

Before Fannie Mae’s announcement, Anish Lohokare, head of mortgage-bond strategy in New York at BNP Paribas, wrote in a note to clients that if both companies followed Freddie Mac’s policy, investors would lose about $12.5 billion in forgone interest.

Freddie Mac said in an e-mailed statement that its purchases would be reflected in reports on its securities published March 4. Fannie Mae said that it will begin to buy loans in March.

“We expect to purchase a significant portion of the current delinquent population within a few-month period subject to market, servicer capacity, and other constraints,” Fannie Mae said.

JPMorgan Chase, Credit Suisse AG and Deutsche Bank AG analysts are among those that have said higher-coupon Fannie Mae and Freddie Mac-guaranteed securities are dangerous because the companies’ buyouts might soon spike.

Adding to Prepayments

“The required adoption of new accounting standards and changing economics” will help speed buyouts, which represent a potential source of mortgage-bond prepayments along with refinancing and home sales, Freddie Mac said.

Aside from more purchases being required by the bonds’ contracts as additional loans get modified under the federal Home Affordable program or fall more than two years past due, accounting-rule changes are forcing all mortgages in Fannie Mae and Freddie Mac securities onto their balance sheets and limiting the financial impact of actual repurchases to the companies.

Losses required under accounting rules that ended Dec. 31 would have boosted their need for capital from the Treasury Department at a cost of 10 percent, greater than the interest owed to investors.

Rose, the New York-based Citigroup analyst, said in a note to clients that after the buyouts are completed, prepayments on Fannie Mae and Freddie Mac securities would be easier to predict, making the bonds less risky, because the debt would have “limited delinquencies” and “limited rate refinancing risk (they have not refinanced in the past 13-months of low mortgage rates).”

Source: Bloomberg