“Treasures on steroids”: trading in mortgage bonds of American banks


NEW YORK / LONDON (Reuters) – Wall Street banks are on track for a record year of revenue from trading in U.S. government-backed mortgage debt, industry sources told Reuters, amid a increased demand – from the Federal Reserve in its fight against the pandemic, and from investors seeking yield.

FILE PHOTO: A Wall Street sign is pictured outside the New York Stock Exchange in the Manhattan neighborhood of New York City, New York, United States October 2, 2020. REUTERS / Carlo Allegri / File Photo

Revenues from trading real estate loan packages at the world’s largest banks – including JPMorgan, Citi and Goldman Sachs, among others – are expected to exceed $ 3 billion in 2020, said a source with direct knowledge of the trading income of the banks, surpassing last year’s peak of $ 2.5 billion.

The source declined to be identified because the data is not publicly available.

“Buying mortgages in March has been one of the best mortgage negotiation opportunities since the last financial crisis,” said Daniel Hyman, head of portfolio management at MBS at Pacific Investment Management Company. (PIMCO).

The increase in demand and activity has also allowed new names to enter the space. Bank of Montreal, which acquired stock broker KGS-Alpha Capital Markets in 2018, now actively trades residential mortgage-backed securities or RMBS, according to the source.

The Bank of Montreal and JPMorgan did not respond to a request for comment. Goldman Sachs and Citi declined to comment.

The trade boom is likely to provide a silver lining in an otherwise difficult time for US banks amid record interest rates and rising bad debts. They start releasing their third quarter results next week, with JPMorgan and Citi kicking off on October 13.

The Fed’s coronavirus stimulus is responsible for the resumption of mortgage bonds guaranteed by government agencies Ginnie Mae, Fannie Mae and Freddie Mac, according to investors.

The premiums required by investors to hold these bonds relative to risk-free Treasury debt, as measured by the Ginnie, Fannie and Freddie MBS ICE BofA indices, were the highest since the 2007-2009 financial crisis in mid -March. This was right before the Fed announced it would increase its holdings of securities, known as the RMBS agency.

Since then, the Fed has bought more than $ 600 billion in agency RMBS and spreads have narrowed by more than 50 basis points.

Chart: US mortgage trade in March was a golden opportunity –

But the Fed isn’t the only one buying. Demand for safe-haven assets surged when the pandemic first hit financial markets, and has persisted ever since. Investors have flocked to RMBS agencies, which enjoy state backing, while offering a higher yield than Treasury debt.

Yields on Treasury bonds have fallen to historic lows since the Fed cut interest rates to near zero.

“MBS agencies are Treasuries on steroids,” said Greg Parsons, CEO of Semper Capital Management, a hedge fund specializing in mortgage-backed securities.

Some investors who bought heavily in March are realizing more than a percentage point of returns above the benchmark, according to investors, a huge return in this rate environment. The PIMCO Ginnie Mae fund generated a return of 4.59% for the year through August, against its benchmark index of 3.32%.

THE RISK OF PRE-PAYMENT

Average daily trading volume in the RMBS agency peaked in March this year, according to data from the Securities Industry and Financial Markets Association, and new issues in 2020 stood at a record $ 2.6 trillion. at the end of September.

Agency RMBS differ from the non-agency variety which gained notoriety for its central role in the 2008 crisis. If a homeowner defaults on a mortgage that is consolidated into an agency RMBS, the agency – Fannie Mae or Freddie Mac or Ginnie Mae – make up for that defaulting principal. Investors in non-agency RMBS, however, absorb the loss.

Although defaults are less of a problem, agency-backed RMBS face significant risk of mortgage prepayments by borrowers, which shortens the term of the collateral and reduces the number of payments made. to investors.

Prepayments increase dramatically when low interest rates allow borrowers to refinance their loans.

Semper Capital does not invest in the traditional RMBS agency precisely for this reason.

“If there is a specific problem that limits the return potential on the agency side, it is that prepayment speeds remain high, which on the non-agency side is strongly positive for the quality and performance of the agency. credit, but the agency side is really holding back the price, ”Parsons said.

But the banks are likely to continue to buy. Although they may be overtaken by the Fed this year, commercial banks currently remain the largest holders of agency MBS. Flooded with deposits during the coronavirus crisis, the big banks put that money at the service of the MBS agency, among other things, bringing their holdings to $ 2.3 trillion according to Fed data.

“If you talk to a company on Wall Street, they are making a huge amount of money selling to banks right now,” said Ken Shinoda, portfolio manager at DoubleLine, who manages strategies that invest both in MBS as well as agency and not agency.

“There is an insatiable demand for agency mortgages by all depository institutions. And deposits are on the rise. Savings rates are on the rise. Everyone is sort of accumulating money.

Editing by Carmel Crimmins


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