NEW YORK -- Tough times in the $2 trillion market for mortgage-
backed securities may be about to get even tougher, as investors
already smarting from hedge fund sales brace for a record pace of
As homeowners rush to refinance their loans with interest rates
near 30-year lows, investors are anticipating a surge in prepayments
of mortgage securities. Those early redemptions hand investors their
money back sooner than expected, leaving them to reinvest at lower
"Prepayments are going to be very heavy, probably a record," in
coming months, said Bob Wasilewski, who manages $2.5 billion in
at ASB Capital Management in Washington.
Expectations for a surge in prepayments come at a time when
investors are already shying away from mortgage securities and
anything else riskier than Treasury debt.
Troubles began in August, when Russia devalued its currency and
defaulted on some of its ruble debt. That wreaked havoc among
holders of mortgage bonds, driving some into bankruptcy and forcing
funds, such as Ellington Management Group, to unload billions of
dollars in securities to raise cash to meet margin calls from
"I've been doing this for 18 years and have never seen a market
like this, where liquidity is just not there," said David Brownlee,
head of fixed-income at Montpelier, Vt.-based Sentinel Advisors,
which manages $11 billion in mutual fund assets. "Hedge funds are
just throwing things overboard."
The hedge fund sales and the approaching wave of early redemptions
has many investors refraining from buying mortgages, or cutting back
on their holdings -- even though, in some cases, the securities are
already as cheap as they have been in more than a decade relative to
benchmark Treasury notes.
The difference in yield, or spread, between Fannie Mae current
coupon mortgage passthroughs and 10-year Treasury notes was recently
178 basis points. That's 113 basis points wider than the average
over the past five years.
"We have a model and it's screaming `cheap,' but we're afraid to
be way ahead of the curve and buy now because the risk is too high,"
said Donald Ross, chief investment officer at National City in
Cleveland, which has $23 billion under management. "We don't know
how big the iceberg is."
Some investors, including Mike Buttner, who manages $26 billion in
mortgages for Charlotte, N.C.-based First Union, are buying mortgage
securities with 6 percent coupons, which are backed by loans with
lower interest rates that are less likely to be refinanced. Buttner
said he's expecting "a big spike in prepayments in the next two
Brownlee at Sentinel Advisors said he "wouldn't want to be in
anything above a 7 percent coupon. You don't know where the prepays
The decline in mortgage rates to the lowest in 30 years has been
driven by a rally in the U. …