Subprime troubles a plus to "agency" MBS -RBS

By Al Yoon

NEW YORK, July 16 (Reuters) - Delinquencies, foreclosures and downgrades on bonds backed by subprime mortgages may steer investors to securities issued by government-chartered Fannie Mae and Freddie Mac for their higher quality, analysts at RBS Greenwich Capital said on Monday.

Mortgage-backed securities issued by the two companies and by Ginnie Mae may get a boost as yields on safer U.S. government bonds fall to unattractive levels, they said. The benchmark 10-year Treasury note yield fell by 5 basis points on Monday to 5.05 percent after a host of subprime loan downgrades last week chipped away at fragile sentiment.

"If flight-to-quality hits Treasuries and makes Treasuries lower in yield, then eventually people start scrambling for spread" as in agency MBS, Alec Crawford, head of MBS strategy at RBS Greenwich, said on a conference call.

Rating companies last week rocked bond markets with downgrades on billions of dollars of first-lien subprime mortgage securities and potential cuts on the more opaque world of collateralized debt obligations, or CDOs.

Delinquencies on subprime loans, already above 10 percent for many lenders, are forecast to rise as tightened underwriting standards make it difficult for homeowners to refinance before their monthly payments reset higher this year and next, analysts said.

Mortgages pooled into securities by Fannie Mae and Freddie Mac are mostly of the "prime" quality, though the two so-called agencies have increased purchases of subprime loans in a move toward mandated affordable housing goals. Wall Street calls the companies federal agencies even though they are not government agencies and their securities are not government guaranteed.

Fannie Mae and Freddie Mac are government-chartered to promoted home ownership, but are publicly traded companies.

Spreads on agency MBS have widened relative to Treasuries as investors fled only to government debt, Crawford said.

Agency MBS also has little risk of losing value if rates rise further, said RBS strategist Ken Hackel. Higher rates can depress prices on bonds paying interest below current issue levels since homeowners are less likely to retire underlying loans and free capital for a better investment.

That "extension risk" has already been factored into prices, he said.

Investors' clamp-down on risk-taking in subprime mortgages and other bonds, including investment-grade corporate bonds, will likely prove an overreaction, he said. But markets will have to endure a "period of time" in which investors tighten their grip on liquidity, or availability of money, he said.

"The real losses as opposed to the market decline are likely to stay fairly well contained," he said.