After Bear catharsis, MBS a win for investors

By Al Yoon - Analysis

NEW YORK (Reuters) - The $4.5 trillion market for the most basic mortgage-backed securities that spread destruction across Wall Street in March has turned into the best place for a bond investor to be.

Mortgage bonds issued and guaranteed by Fannie Mae, Freddie Mac and the Federal Housing Administration have posted nearly 3 percentage points in returns over U.S. Treasuries since March 6, the best performance among investment-grade debt, including corporate bonds and other asset-backed securities, according to Lehman Brothers indexes.

It was the fastest-ever rebound for MBS and the other debt since the investment bank has tracked excess returns on debt that trades at a yield premium over government bonds. It is the fruit of efforts by the Federal Reserve after watching borrowing rates tied to MBS, a rare support to the ailing U.S. housing market, begin to rise.

The resolve for investors who consider MBS some of the safest securities was tested. MBS returns lagged Treasury debt by 2.94 percentage points as of March 6 as their yield spreads reached their widest level in more than two decades. MBS are now outperforming on the year.

"A bet against the mortgage market is a bet against the Fed, and the Fed isn't going to lose this game," said Todd Abraham, co-head of government and mortgage debt at Federated Investors Inc., which manages more than $300 billion.

Mortgage rates are partly a product of the price the lender can get for the loan in the MBS market.

Because MBS had been seen as virtually riskless, except for interest-rate swings, they became the favorite of many hedge funds that borrowed at low short-term rates to invest in longer term debt. This so-called leveraging came to an abrupt end for many, leading in part to the fall of funds run by Carlyle Capital Corp. and Peloton Partners.

The importance of MBS from Fannie Mae and Freddie Mac, which were chartered by the U.S. Congress to support the housing market, to the U.S. economy likely sparked the Fed to allow investment banks to access its short-term lending facility, investors said. The MBS market's precipitous drop and subsequent rebound also roughly book-ended a Fed-brokered deal to prevent the collapse of Wall Street's Bear Stearns Cos.

The steep drops in MBS in early March "seemed like the real end of the world moment" for the markets, Laura Alter, head of fixed income at Harris Investment Management, said on a panel hosted by the Mortgage Bankers Association on Tuesday.

Sharp recoveries for credit markets -- this being the fastest since Lehman Brothers began tracking excess returns in 1989 -- also tend to be short-lived, giving way to a plateau in yield spreads, said Joseph DiCenso, a fixed-income strategist at Lehman.

The rally in MBS faltered on Friday, breaking more than a week of consecutive gains after the head of Citigroup Inc., the biggest U.S. bank, said his company would unload $400 billion in assets over the next two to three years. The comments, which reminded investors de-leveraging of balance sheets isn't over, fueled sales of MBS to capture profits from the recent rally.

Ongoing concern that the U.S. economy may slip into recession amid corporate losses, falling home prices and rising energy costs could work in MBS favor, relative to corporate debt, DiCenso and other analysts said.

"It's not uncommon that you see mortgages do better than (corporate) credit in recession periods," Versus corporate bonds that are exposed to a company's weaknesses, agency MBS "are almost like the anti-credit" since they have backing from government-chartered companies, he said.

Freddie Mac and Fannie Mae gross issuance last year topped $1 trillion, and is expected to grow in 2008 with the seizure of competing programs from Wall Street banks.

Fannie Mae and Freddie Mac are also the biggest investors have stepped up purchases of MBS after raising capital and being freed from constraints by their regulator. Freddie Mac in March entered contracts to buy $43.5 billion in mortgage assets, the most since mid-2003.

(Editing by Leslie Adler)