Deutsche Bank recently released research titled “The Outlook in MBS and Securitized Products” finding that although a large piece of the market focuses on bank demand for mortgage-backed securities (MBS), not much focus has been placed on the shape of that demand. The report also noted that banks are adding longer lengths on MBS that would drop in value as rates go up.
“If this happens banks will need to top off their existing stocks of liquid assets to maintain their current levels of liquidity coverage,” Deutsche reported. “Based on asset growth, banks look poised to add roughly another $35 billion of MBS this year but it could be more if rates rise and banks are forced to top off existing stocks of HQLA.”
Banks appear to be gearing up to add longer duration MBS due to large bank net interest margins being low and under pressure, a growing allocation of MBS in held to maturity (HTM) portfolios, and large banks taking more defensive positions in their Treasury holdings, the research found.
According to the outlook, the total number of assets at the top 50 bank holding companies grew about 1.1 percent in the first quarter. MBS including Ginnie Mae, conventional MBS, and CMOs accounted for approximately 7 percent of total assets. If the rate of growth and ratio of MBS to total assets is held constant, bank can expect to add an additional $36 billion of MBS for the rest of 2015.
Banks’ aggregate pass through exposures increased by nearly $70 billion since the beginning of 2012, Deutsche reported. Also in 2012, their holdings of 30-year pass-throughs has increased nominally by 5 percent to a total of $90 billion.
Deutsche credits a number of reasons for banks being driven to high-yielding, longer MBS such as the decline of net interest margins (NIMs) at large banks. The drop in NIM pressure is largely due to liquidity mandates and weak loan growth.
“The clear net effect of all these influences is the incentive for banks to increase duration of MBS portfolios but that too comes at a cost,” Deutsche said. “By extending duration banks are still exposed to the mark-to-market on those assets when they calculate the value of their stock of HQLA as rates rise. How much and how fast the stock of banks’ HQLA declines in value should be the primary driver for bank demand to surprise to the upside.”
The Deutsche outlook also identified single-family residential (SFR) rental markets where rent appreciation was higher than home appreciation, an important and necessary condition for SFR investors. In the largest metropolitan statistical areas (MSAs), 44 markets experienced year-over-year increases in rent, while rent appreciation exceeded home price appreciation in 25 of the 50 top housing markets.
Providence, Rhode Island had the highest year-over-year gross rental yield appreciation at 26.4 percent, the bank reported. Newark followed with 16.4 percent, Baltimore with 14 percent, Kansas City with 11 percent, and St. Louis with 8.1 percent.
Residential ABS issuance was $6.4 billion in May, and the issuance for this year is $31.3 billion, a 134 percent increase from 2014, the bank says. The bank predicts that the issuance of residential ABS remains will remain between $45 billion and $58 billion for 2015.
“U.S. housing has had a remarkable recovery that is broad-based across different geographic regions, the bank reported. “Home price appreciation has also been evident in various transaction types consisting of foreclosure sales, short sales, new construction and normal existing home sales. Depending on the depth of distress housing inventory, some regions have had large price appreciations on single family properties that put downward pressure on gross rental yields. However, rising acquisition price does not necessarily lead to declining gross yield. The opposite could be true in the local market with faster rent appreciation.”
Click here to view the complete “The Outlook in MBS and Securitized Products” report.