By the Numbers
Parsing recent trends in depository demand for MBS
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Large domestic depositories grew their securities portfolios by upwards of $55 billion last quarter. But the shape of demand appears to have varied based on the size of the institution. MBS pass-throughs broadly fell out of favor with both larger and smaller banks last quarter. Downsizing of MBS portfolios at the largest banks looks to be a rotation out of pass-throughs into Treasuries. While depositories both large and small look to increasingly be favoring CMOs over pass-throughs. Net demand for securities appears poised to remain elevated through the end of the year given growing concerns around recent defaults in both secured and unsecured lending books.
Banks with more than $100 billion in total assets grew their portfolios by $56 billion to $4.33 trillion last quarter, representing a 1.3% increase in total holdings and accounting for 26% of total assets across the largest US banks. Portfolio growth should remain steady through the end of the year as underwriting standards and the credit box which banks lend into appears poised to tighten against the backdrop of what appears to be idiosyncratic but at a minimum, more frequent defaults and bankruptcies among corporate borrowers. Increased demand for securities may not translate into dollar-for-dollar demand for MBS though, as large money center banks may continue to add Treasuries over MBS.
Money center banks grow Treasury holdings in the third quarter
Large US depositories added $57 billion in Treasuries in the third quarter, exceeding total net securities additions for these banks. As is often the case, big swings in holdings can be driven by activity from money center portfolio rather than more broad- based trends across institutions and that was certainly the case in the third quarter as JP Morgan Chase, Bank of America and Wells Fargo added nearly $60 billion in Treasury exposure throughout the quarter. Conversely, depositories with total assets between $100 and $500 billion decreased holdings of Treasuries by roughly $4 billion.
One plausible explanation as to why money center banks may be willing to forego additional spread and yield afforded by more negatively convex MBS is the composition of money center banks’ liabilities relative to their smaller peers. Into a Fed easing cycle, money center banks may be able to more quickly and aggressively reprice large corporate deposits while asset yields remain somewhat stickier, expanding their net interest margins as the Fed cuts benchmark rates. That margin expansion affords banks the ability to reduce negative convexity on the asset side of the balance sheet, and potentially duration as well. With swap spreads out the curve being meaningfully negative, banks can asset swap longer duration Treasures back to floating and earn spreads of 30 bp to 50 bp over 1-month SOFR depending on the tenor of the Treasuries being swapped. And by going out of MBS into Treasuries, banks can reduce duration, negative convexity and mortgage basis risk in exchange for Treasury/SOFR swap spread duration risk.
Pass-throughs fall out of favor across the depository base
Both money center and regional banks reduced net holdings of both Ginnie Mae and conventional pass-throughs in the third quarter. Net holdings of both Ginnie Mae and conventional MBS fell by roughly $12 billion respectively over the 3-month period, with the declines attributable to passive deleveraging rather than active selling across most institutions with a couple of notable exceptions. The two largest US depositories, JP Morgan and Bank of America, saw pass-through holdings go in opposite directions as JP reduced holdings of Ginnie Mae MBS by nearly $15 billion while adding roughly $8.5 billion of convention al MBS. Bank of America increased holdings of Ginnie Mae MBS by $6 billion while reducing conventional holdings by nearly $13 billion. The contra-directional move by the two portfolios may be attributable to volatility in Ginnie/Fannie swap spreads over the quarter as the basis between the two contracts widened steadily throughout most of July and August, creating an opportunity to add Level 1 HQLA and rotate out of conventional MBS at relatively wide spreads, before tightening by roughly half a point in September, creating an opportunity to trade out of Ginnie Mae MBS at nearly 1-year tights.
Depository demand for CMOs remains strong
While pass-through holdings declined in the third quarter, holdings of CMOs increased modestly, eking out an increase of roughly $2.5 billion on a net basis. Growth in CMO holdings was, somewhat surprisingly, driven by money center banks as Bank of America and Wells Fargo collectively added roughly $5.5 billion in CMOs. Growth in CMO holdings at money center banks is somewhat surprising as they have historically leaned into more favorable liquidity offered by pass-throughs. The migration into more CMOs from large banks likely speaks to the overall growth in CMO issuance and more broad-based demand for the asset class from both asset managers and foreign investors which, in turn, has improved overall liquidity in the sector, particularly in floaters where trade volumes continue to grow. Increased participation in the CMO market from larger depositories should translate to continued tightening in spreads, particularly in higher cap floaters which appear to be the preferred exposure for large US banks.
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