Fourth quarter earnings data offered some worrisome news for banks' support of the mortgage market once the Federal Reserve ends its MBS purchases, Deutsche Bank Securities analysts said.
The analysts noted that the data showed a divergence between banks and the broader economy in terms of the continued stagnation in loan growth. This is even though the real economy has moved into positive territory and job losses have gone down significantly.
At the same time, fourth quarter earnings data showed bank holdings of total loans, residential mortgage loans and agency MBS were little improved and even shrunk at some banks, analysts added.
"Thus, after the Fed's exit from quantitative easing at the end of March, we don't expect banks can be relied upon for supplying liquidity and credit to the housing market and the broader economy as a whole," they said.
Based on analysts' current outlook, they don't believe banks will be substantial buyers of mortgages — even after the Fed exits the market at the end of March.
As a result, "in the long term, the omission of banks from their historical central role in the mortgage market is negative for that market," they said.
Still, Deutsche analysts do not see MBS immediately cheapening when the Fed's support goes away. They expect money managers will be supportive given their substantial underweight currently. Analysts noted that money managers will need to increase their allocations to avoid risking underperforming the broader index.
Other near term supportive factors for the market include ongoing favorable carry with rates near zero as well as relatively low prepayment rates despite historically attractive mortgage rate levels. "These factors could act to keep MBS spreads from widening substantially, at least in the short term."
In their outlook for 2010, Deutsche Bank analysts were on the low end for bank demand for agency MBS versus other major Wall Street firms at $100 billion. The average demand from banks was pegged at around $158 billion, with other demand sources estimated at $139 billion (Fed) and $63 billion(overseas investors).
With net supply estimated at $320 billion, even at the low end, the technicals appear generally favorable with the difference appearing manageable given underweight money managers.
Clearly these numbers will be revised in the weeks and months ahead as more information becomes available.
