Even with the 10-year Treasury rate backing up considerably in the past few weeks, and with market participants expecting the Federal Open Market Committee to tighten by 50 basis point increments going forward, bank MBS holdings are still not decreasing as of yet.
In a recent report, RBS Greenwich Capital MBS analyst Linda Lowell wrote, "there is no publicly available evidence that the large U.S. banks have yet begun to retreat from very sizable MBS exposures," adding that total security and MBS holdings continued to increase through March 16, which is the most recent data released. "There is no indication that anything has yet altered the strategies of the large commercial banks that have played such a large role in MBS markets over the last four or five years," added Lowell.
In fact, Federal Reserve and Credit Suisse First Boston data show total bank MBS holdings rising by $50 billion to $891 billion from $841 billion over the first quarter of the year. Interestingly, the increase comes at a time when C&I loan production jumped $23 billion to $803 billion.
RBS Greenwich's Lowell believes that despite the yield curve flattening, rising rates and increasing loan demand, banks are too flush with deposits to give up security investments, adding that consumer disappointment with the stock market as well as strong internal corporate cashflows are probably driving these deposits. Lowell suggested that the strength of these two factors should typically dip with the economy improving. Specifically, C&I lending usually grows more quickly as corporations work down cash positions - implied by the significant amount of non-transaction deposits - through investing in equipment, plant and production expansion.
Lowell noted that as a percentage of bank assets, securities currently total just under 24%, at par with levels held before the bond back up and "MBS debacle" occurring in summer 2003. The composition of these security holdings - with MBS making up over 50% - may lead to banks holding the additional interest rate risk in exchange for carry. Additionally, the majority of the growth in bank MBS holdings is in passthroughs, not CMOs, implying increased extension risk. Currently, the large U.S. commercial banks hold 22% of their MBS exposure in CMOs. After dipping from its 2003 historical peak, residential loans in portfolios have risen through 2004 and 2005.
In a related report, JPMorgan Securities cited the $12 billion C&I loan demand growth in March, noting that Federal Reserve data indicates that only in the last two months have larger banks seen loan demand growth. Analysts pointed out that historically, C&I loan growth has come with a dip in mortgage security and loan holdings with the correlation being stronger in residential loan holdings relative to securities. This could mean that increased C&I demand would cause banks to retain less whole loans, increasing their securitization rate instead. This is expected to have a bigger supply impact on ARMs than on fixed-rates, analysts wrote.
Additionally, large commercial banks have aggressively added HELOC holdings during the residential mortgage boom. Although this has slowed as mortgage demand wanes, it is still maintaining a roughly 40% pace. RBS Greenwich's Lowell wrote that this significant increase in HELOC s implies that cash out refis might be relatively less of a source for new mortgage originations in a bear market. "Home equity lines of credit are cheaper, easier way to tap equity than taking out a new mortgage, a fact we believe the average homeowner has now caught onto," Lowell stated.
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