By GRETCHEN MORGENSON and VIKAS BAJAJ
Published: June 15, 2007
Now that party may be coming to an end.
Economists said homeowners trying to refinance their adjustable rate mortgages before they reset to higher levels are already feeling pinched. The national average for the 30-year fixed-rate mortgage jumped to 6.74 percent yesterday. At the beginning of the year, the average was 6.18 percent, according to Freddie Mac, a big buyer of mortgages.
“It’s going to be tough,” said Adam L. Stein, president of the Washington Association of Mortgage Brokers near Seattle. “I talk to people every day looking to get the fixed rate. You give them the current rate and they say, ‘That doesn’t do anything for me.’ ”
Homeowners are not the only ones who will have to swallow higher costs. Corporations, accustomed to financing operations with cheap debt, will see their expenses rise, cutting into profits. In addition, rate increases will crimp the private equity buyout boom, which has been fed in large part by the heavy issuance of corporate debt at low rates.
“There has been a half a percentage point rise in rates while inflation has been flat, so the real cost of capital has gone up for consumers and for corporate America,” said Mickey Levy, chief economist at Bank of America. He said he expects that the increase will put pressure on stocks and damp already weak demand for housing.
The recent rate move came as something of a surprise to Wall Street. It is the result, traders say, of heavy selling by foreign investors, who may be growing concerned about inflation, and holders of mortgage securities hoping to reduce the risks associated with higher rates.
While the Federal Reserve Board sets the nation’s interest rate policy, buyers and sellers in the Treasury market drive the rates that affect both consumer and corporate borrowers. Bond yields rise when prices fall. The 10-year Treasury note stood at 5.22 percent at the end of trading yesterday, up from 4.7 percent a month ago.
Adding to concern over rising rates, the Labor Department reported yesterday that producer prices rose 0.9 percent in May, more than forecasters had expected. The government will release May’s consumer price figures today.
Stocks have so far shrugged off the jump in interest rates. The Dow Jones industrial average closed at 13,553.72 yesterday, up 71.37 points; the average is 0.8 percent below its high of June 4.
Some bond strategists said the recent rate spike is only the beginning. The sharp increase, they said, is just starting to bring interest rates back to their normal or long-term trend levels.
“Bond yields have been so low for so long,” said Richard Suttmeier, chief market strategist at RightSide Advisors. “But yields in the 10-year have moved up almost 100 basis points since the end of February. That, to me, is a big shock and enough for people to take notice.”
Particularly hard hit will be consumers with weak credit — known as subprime borrowers — who are faced with mortgage rates that will soon reset to higher, in some cases double-digit, levels. Some $100 billion in subprime loans are scheduled to reset between now and October.
Even before the latest rate increase, borrowers who were refinancing their mortgages were paying higher prices to do so. In the first quarter of 2007, Freddie Mac said, half of the borrowers who paid off their original loans and took out new ones absorbed an average increase in interest rates of three-eighths of a percentage point.
Betty King, a 42-year-old single mother of two in St. Louis, would like to refinance the adjustable rate mortgage on her three-bedroom townhouse but cannot. Her $1,200 monthly payment would rise too much. Her loan, with a rate of 5.9 percent, is scheduled to reset next year.
“Right now, it doesn’t pencil out for me,” said Ms. King, who works part time at an online travel site so she can spend time with her teen-age daughters.
A. W. Pickel III, a mortgage banker who is working with Ms. King, said several clients are in similar predicaments.
“I don’t think they are panicked,” he said. “But now they are wishing, ‘Why didn’t I take a fixed rate three years ago when I had the chance and rates were low.’ ”
Higher rates are already contributing to an increase in foreclosures. The share of mortgages entering foreclosure in the first quarter of 2007 rose to 0.58 percent, the Mortgage Bankers Association said yesterday, up from 0.54 percent in the previous quarter.
RealtyTrac, an online provider of foreclosure data, reported Tuesday that foreclosures in May were up 90 percent from the period a year earlier. Although RealtyTrac’s figures may overstate matters somewhat by reflecting loans in each step of the foreclosure process, the total foreclosures of 176,137 in May were sobering.
For struggling homeowners, the rise in rates could not come at a worse time. “In prior foreclosure waves, we had a drop in interest rates that allowed workouts to be done at lower interest rate levels,” said Louis S. Barnes II, a partner at Boulder West Financial Services, a mortgage banking firm in Lafayette, Colo. “Today rates are substantially higher than when a lot of these loans were created.”
In Florida, a glut of homes on the market combined with rising insurance premiums and higher interest rates will mean a slower recovery, said Patrice P. Yamato, a mortgage broker in Jacksonville and president of Florida’s mortgage broker association. One potential client, she said, decided not to buy a new home because the jump in rates meant a monthly payment of $500 more than what she would have paid a few weeks ago.
Consumers will not be the only ones encountering higher borrowing costs. Corporations will also have to absorb greater expenses, putting pressure on profits and stock prices.
“The trajectory of corporate profits has flattened out after growing in double digits for several years,” Mr. Levy said. “The stock market could handle that when rates were low, but a 50-basis-point rise in real bond yields should have dampening impact on stock valuations.”
The private equity buyout boom that has contributed to the bull market in stocks will also face headwinds. While prevailing rates remained below 5 percent, deals financed by corporate debt issuance worked well. As rates move up, the economics of selling big bond issues to pay for the deals becomes more difficult.
This week, Alltel said that it would take on about $21.7 billion in debt to pay for the transaction. About $14 billion of that debt will be secured loans, but Alltel must sell $7.7 billion in bonds to get the deal done.
Assuming the bonds carry an 8 percent to 9 percent interest rate, the range for comparable telecommunication debt issued recently, Alltel will probably spend almost all the cash that it earns to service the debt, said Ping Zhao, a senior analyst at CreditSights. Ms. Zhao further assumes the company’s service revenue will grow 7.3 percent this year.
Alltel could prove to be a critical test of investor sentiment, said Kingman Penniman, chief executive of KDP, a bond research firm. “The first cracks will appear when you can’t do the $14 billion or the $8 billion deals,” he said.
For now, investors still appear to be receptive, said Andrew Feltus, a high-yield fund manager at Pioneer Investments. “The market seems to be saying, ‘I have got the money, I have got to put it to work.’ ”