Mortgage-Backed Funds Lag on Refinancing Fears

Article excerpt

How many homeowners are out there waiting to refinance their mortgages? Maybe not many, but fear of a second refinancing boom has investors undervaluing mortgage-backed securities, according to some experts.

"Investors are fighting the last war," says Randy Merk, senior vice president at Benham Group, which offers a mortgage-backed bond mutual fund.

"These bonds have been selling at prices that assume there will be another huge wave of refinancing. We think that fear is greatly exaggerated."

It works like this: So-called Ginnie Mae mutual funds are comprised of government-backed mortgages, like FHA and VA loans. They pay decent yields - currently around 7.4 percent - because that's what homeowners pay on the mortgages in the portfolios.

When mortgage rates come down, these funds can rise as their fixed-rate portfolios become more valuable.

But that's tempered by the fact that homeowners are smart: They have a tendency to pay off expensive mortgages and get cheaper ones.

If you are sitting on a portfolio of 8 percent mortgages, for example, and rates drop to 6 percent, you may end up with a fund full of cash that you have to reinvest at 6 percent as mortgaged homeowners refinance.

Fears that recent rate declines make these refinancings more likely have investors limiting their purchases of Ginnie Mae funds.

According to Morningstar, the mutual fund tracking service from Chicago, these funds have underperformed as a result.

The question, for bond-buying opportunists, is this: How much of a threat is this right now?

Not much, say some fund managers. A great wave of refinancing took place just over a year ago, and many of those homeowners are unlikely to refinance again now, with rates at similar levels.

Casey Colton, manager of the Benham fund, notes that most FHA and VA mortgage homeowners would not find a refinancing worthwhile. …