US mortgage refinancing offers hope of stability

January 30, 2008 Wednesday
Asia Edition 1
BYLINE: By MICHAEL MACKENZIE and SASKIA SCHOLTES
SECTION: MARKETS & INVESTING; Pg. 23

Amid the steady drumbeat of bad news for the US housing market, there are hopes that a recent dramatic fall in mortgage rates could help struggling homeowners refinance into cheaper loans, offering the prospect of much needed stability.

But contrary to earlier periods when low mortgage rates prompted waves of refinancing activity, analysts say the silver lining could be tarnished by today's stricter lending standards, virtually closed securitisation markets and still high rates for non-conventional mortgages - all this while the dark cloud of falling house prices hovers over new buyers.

"Financing costs may have come down for some but it would take an extreme optimist to see any break in the price slide," says Alan Ruskin, strategist at RBS Greenwich Capital.

The decline in US home prices accelerated in November, with the Case-Shiller index for 20 major cities down 7.7 per cent year on year. It was the largest fall in prices since the index was created in 1988.

Nevertheless, interest rate cuts from the Federal Reserve and lower US government bond yields have helped drive mortgage rates for conventional 30-year mortgages - those that can be financed by government-chartered mortgage companies Fannie Mae and Freddie Mac - below 6 per cent for the first time since 2005.

This is because Treasury yields are the reference point for long-term fixed-rate home loans and, last week, the yield on the 30-year bond fell to a historic low of 4.10 per cent.

The average conventional borrower is currently paying an interest rate of 6.14 per cent on an existing 30-year mortgage, according to data from Bear Stearns.

For new mortgages, the average rate for a home loan of this type is 5.45 per cent. This means borrowers in more than 60 per cent of outstanding conventional mortgages, representing about Dollars 2,700bn, have an incentive to refinance into a cheaper home loan.

As a result, mortgage applications, especially for refinancing, have surged in recent weeks, say analysts at HSH Associates, a consumer loan research firm.

But the capacity for making new mortgages may be limited. Bank balance sheets remain constrained, and securitisation markets have ground to a halt for all but the highest quality mortgages.

"It's possible that an upsurge in demand for mortgage credit may run into a limited supply," HSH says.

Meanwhile, some borrowers may find that tighter lending standards and still high rates for non-conventional mortgages do not deliver the sort of relief for the household budget they hoped for.

"In principle, you can say lower interest rates deliver cost savings for owners of home loans but, in practice, (the savings) will be substantially lower this time," says Dominic Konstam, head of interest rate strategy at Credit Suisse.

This is because the refinancing opportunity is predominantly limited to borrowers who qualify for conventional mortgages.

For creditworthy borrowers with so-called "jumbo" mortgages, that is, for loans of more than Dollars 417,000, mortgage rates remain elevated at 6.56 per cent, still more than a full percentage point higher than conventional mortgages. Normally the difference is about 0.2 per cent.

The average jumbo borrower is paying an interest rate of 6 per cent on a current 30-year mortgage, according to Bear Stearns, so the only incentive to refinance is if they can somehow qualify for a conventional mortgage.

Borrowers could do this by reducing the size of their loan but they would need to meet the tighter lending standards and higher refinancing costs prevalent in today's mortgage market.

"Most of the refinance transactions will require reappraisal with borrowers in declining markets facing substantially higher costs," says Dale Westhoff, mortgage analyst at Bear Stearns.

This means mortgage rates may need to drop further still before borrowers are inclined to refinance their mortgages.

"Rates need to drop a lot more now than they did in the past in order to deliver the same kind of refi wave," Mr Konstam says. He points out that 10-year Treasury yields may need to fall closer to 3 per cent - against the current 3.68 per cent - to have the same effect in today's market conditions.

David Rosenberg, chief US economist at Merrill Lynch, says the recent proposed lifting of mortgage lending caps for Fannie and Freddie to Dollars 730,000 from Dollars 417,000 as part of the US administration's economic stimulus package "will probably help ease some of the pressure in the non-conforming mortgage market".

But "the overall impact is going to be pretty modest" because almost 60 per cent of the jumbo mortgages originated in the past three years were interest-only, which Fannie and Freddie are not allowed to guarantee.

Yet, the ability of lower credit quality borrowers to refinance into new mortgages remains uncertain, given the shutdown in bank lending and securitisation.

But the Federal Reserve's interest rate cuts and a sharp decline in money market rates have offered some subprime borrowers a ray of hope because adjustable-rate mortgages are benchmarked against interbank lending rates, or Libor.

Six-month Libor has eased to 3.18 per cent from about 5.15 per cent at its peak in October, meaning that subprime borrowers facing a interest rate reset will see their payments go up by about half what they could have faced in October.