MBS leads bank asset growth
admin | May 3, 2019
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Since US banks hold more than $3.6 trillion in securities and $9.7 trillion in loans and throw that weight around in a wide range of markets, their investment appetite matters. The most appealing items on the early 2019 menu seem to be MBS, both agency and private, which are growing on bank balance sheets at a pace far outstripping other securities or loans and as excess reserves plunge.
With total assets up 0.9% so far this year, banks have grown their holdings in private MBS by 5.5% and agency MBS by 4.5% (Exhibit 1). Private MBS still amounts to a small $77 billion as April 17 with agency MBS at $1,958 billion. Nevertheless, the interest in MBS is notable especially with holdings in residential mortgage loans up by a smaller 1.0%. Banks are either converting mortgage loans into securities for credit and liquidity or reaching into the market for liquidity and spread.
Exhibit 1: Growth YTD in MBS is outstripping other bank assets
Note: Growth from 12/31/18 to 4/7/19. Source: Federal Reserve, Amherst Pierpont Securities
One possible spur to the MBS interest is the nearly 13% drop in cash, which is mainly excess reserves. The continuing drop in the Fed’s portfolio of Treasury and agency debt and MBS by design takes cash out of the banking system, so the drop is no big surprise. But excess reserves also help meet regulatory liquidity requirements. At least with agency MBS, banks may be adding securities to make up for drawdowns in cash.
The Fed late last year proposed a new set of liquidity regulations that would ease demand for excess reserves and other liquid securities for a broad set of banks. The Fed also this month started slowing the reduction in its Treasury holdings
and plans to end reduction in total securities balances by late September. That should dampen if not end the drawdown in cash assets, dampening the likely correlated demand for MBS at the same time.
The MBS market seems to have the wind of bank liquidity demand at its back for now, but that looks likely to fade by the fall.
* * *
The view in rates
Concerns about low inflation have started to weigh on Treasury yields. The yield on 2-year notes remains at 2.33% The market still sees the probability of a cut or a hike at 50/50, and the Fed seems to be reinforcing that message. The market is also comfortable pricing 10-year yields right around the Fed’s target rate. Eventually, growth should push 10-year rates a little higher, with fair value above 2.75%. However, if the debate on rates is now tightly focused on whether the Fed will cut or hike by 25 bp for the balance of the year, then rate volatility seems far away.
The view in spreads
A relatively flat yield curve, low volatility and heavy net supply of Treasury debt should steadily tighten spread markets. The longer the Fed remains patient, the longer the spread advantage in assets other than Treasury debt compound to the advantage of portfolio return. Leverage and loosening of underwriting remain a concern in investment grade corporate debt and leveraged loans, but concerns about recession, which would trigger those vulnerabilities, has diminished. Agency MBS could see a softening of bank demand, but it should still outperform credit.
The view in credit
Companies have started to divert cash flow toward paying down debt, have started to sell non-core assets and have curtailed stock buybacks. Management has heard the concerns of debt investors. Households continue to look strong with low unemployment, rising home prices, and generally good performance in investment portfolios.
1 (646) 776-7714
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.