Overseas investors and banks are expected to be key new buyers of agency MBS once the Federal Reserve ends its purchase program, Barclays Capital analysts said.

They estimated that a total of $230 billion will need to be absorbed by other investors, including overseas investors, banks and money managers. The growing trade deficit and persistently steep yield curve, according to analysts, will lead to overseas investors and banks, respectively, to increase MBS holdings.

The expected demand from overseas investors and banks is estimated at $150 to $250 billion, enough to absorb the maximum $230 billion required, Barclays analysts said.

Bank MBS holdings are essentially unchanged since January 2009. These insitutions have effectively sat on the sidelines while the Fed has stabilized the housing market. Although banks might want to wait for better buying opportunities in MBS, analysts said the persistently steep yield curve will likely force them in as buyers — sooner than later.

“Banks may not want to buy MBS at current levels but lack of opportunities elsewhere — sluggish mortgage demand (MBA purchase index at lowest levels since 1997) and declining C&I loan holdings (down over $100 billion in 2009) growth — likely will leave them little choice,” Barclays analysts said.

Based on pre-crisis levels, Barclays estimated a net MBS purchase by banks of $100 to $150 billion. Other investors are harder to gauge, and likely will try to be more opportunistic.

“If banks and overseas investors emerge as buyers, as we expect, we would expect these other investors, such as money managers and insurance companies, would also gain confidence that the big spread blowout is not coming, and begrudgingly increase their mortgage exposure from an underweight position,” analysts said. “In short, we believe demand for mortgages will be there as the Fed exits its crisis policy phase.”

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