Banks `Throw in Towel' to Add Most Mortgage Bonds in 18 Months
The biggest banks are adding government-backed mortgage bonds at the fastest pace in 18 months, breaking with an unusual pattern in which they shunned the debt as their loan portfolios shrank during the economic slump, according to Barclays Capital.
Large U.S. commercial banks added $51.4 billion of so- called agency mortgage-backed securities in the two weeks ended July 21, according to the latest data released by the Federal Reserve. The holdings fell from $696.6 billion in the middle of 2009 to $687.2 billion on July 7 even as the lenders’ portfolios of Treasuries and agency corporate debt grew $104 billion.
Large banks, which now hold $736.8 billion of the securities, avoided the debt as the Fed’s $1.25 trillion of buying drove down yield premiums to record lows relative to 10- year Treasuries, and acquisitions by private investors then restrained spreads.
The increased likelihood the Fed will hold its benchmark for short-term rates at record lows for longer as the economy struggles and that spreads will stay tight amid limited supply have pushed “some banks to throw in the towel on the waiting game,” Barclays analyst Derek Chen wrote yesterday in a report.
“The tipping point has been the growing conviction that rates are not heading higher and mortgages are not heading wider anytime soon,” Chen, who is based in New York, said today in a telephone interview. “They’re not going to find a better opportunity. The longer they wait, the more money they are wasting” on holdings of cash or lower-yielding assets.
Price, Yield
Nomura Holdings Inc. mortgage-bond strategists wrote today in a report that the mortgage-bond figure shouldn’t be taken to be a definitive sign of “a real uptick in bank demand.”
Buyers from outside the U.S. have been flocking to the market for months, according to separate data from the Fed and Treasury Department. The amount of agency mortgage bonds and agency debt held at the Fed for foreign central banks, sovereign wealth funds and other official investors has risen by $70 billion to $830 billion on July 28, from a more-than-two-year low in November, its data show.
The average price of the $5.2 trillion of mortgage bonds guaranteed by government-supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae climbed to a record 106.9 cents on the dollar yesterday, up from 106.2 cents on June 30, according to Bank of America Merrill Lynch’s Mortgage Master Index.
Fannie Mae Yield
Fannie Mae’s current-coupon notes, or those trading closest to face value, yield 3.54 percent as of 5 p.m. in New York, according to data compiled by Bloomberg. That’s 0.64 percentage point more than 10-year Treasuries, up from a record low of 0.54 percentage point reached July 30, Bloomberg data show.
Checking accounts, among the means through which banks raise money that they can invest in securities, pay depositors 0.53 percent on average, according to Bankrate.com data. Rates on the accounts typically vary based in part on the Fed’s target rates. A rise in banks’ deposits, which Fed data show growing for large banks by $37 billion from April 21, has contributed to their desire to invest more in mortgage securities, Chen wrote.
While the Fed data on banks’ mortgage-bond portfolios “tend to be volatile, the magnitude of the increase seems too big to be dismissed as noise,” Chen said in his report. If banks are back in the market, they have “potential to absorb” more than $150 billion more of the securities, which would “bode very well” for spreads, he wrote.
Nomura Analysis
In the Fed data, most of banks’ holdings are reported based on market values, not purchase prices. Large banks are defined as the 25 domestically chartered banks with the most assets, excluding thrift banking companies.
The Nomura analysts led by Ohmsatya Ravi, the New York- based head of the Japanese company’s U.S. securitization products research, wrote “most likely, more than half of this growth came from rebalancing of servicer” hedges and that those loan-management units may have been taking delivery of new bonds directly from the lending arms of their companies.
As loan rates decrease, the expected average lives of loan- servicing contracts decline as potential refinancing increases, reducing the value of the contracts. To protect against that risk, servicers may hold debt whose values usually rise when rates drop, including mortgage bonds whose durations also change at the same time, requiring a reworking of that hedging.
In early July, refinancing applications rose to the highest since May 2009 amid record-low mortgage rates, while remaining more than 45 percent below a peak in January 2009 with many borrowers unable to qualify after the worst housing slump since the 1930s, according to Mortgage Bankers Association data.
Reported Bank Holdings
“To the extent that servicer duration rebalancing is done and yields are at the lower end of the range, one important support for the MBS market should go away from now onwards,” the Nomura analysts wrote.
Large banks’ reported holdings of non-agency mortgage securities, whose tumbling values caused the worst financial crisis since the Great Depression, rose from last year’s low of $153.2 billion to as high as $181.7 billion in September amid price gains, before declining to $146.5 billion as of July 21, Fed data show.
All U.S. commercial banks hold $1.05 trillion of agency mortgage securities, and $183.7 billion of non-agency bonds, according to the Fed data.
As U.S. banks made little change in size of their agency mortgage-bond portfolios for more than a year, they shifted into holding more slices of collateralized mortgage obligations rather than simpler bonds, adding $98.2 billion in the 12 months through March, according to latest available Federal Deposit Insurance Corp. data.
Cash Assets Rise
CMOs repackage agency mortgage bonds into new securities that react differently to changes in the speeds at which the underlying loans pay off, with some tranches limiting the risk that the buyers’ assets will remain outstanding for longer if interest rates rise.
All U.S. commercial banks’ cash assets have risen to $1.25 trillion, from $941.1 billion in June 2009, while their loans have shrunk $200.5 billion to $6.84 trillion, a number inflated by an accounting change that in March required more securitizations to be included on their balance sheets and triggered a more than $300 billion jump in their reported lending, Fed data show. The largest banks’ loans have declined by $89 billion since April to $3.92 trillion.
To contact the reporters on this story: Jody Shenn in New York at jshenn@bloomberg.net;
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