MBS and deposit activity at the top 25 U.S. commercial banks in 4Q06 showed solid MBS sponsorship, according to the JPMorgan Securities bank quarterly update.

Total MBS holdings increased by $16 billion and comprised $13 billion in passthroughs and $3 billion in CMOs, JPMorgan analysts reported. Year-over-year total bank holdings at these 25 banks surged by $70 billion, which doubled that of 2005, analysts said. Year-to-date, banks have bought another $10 billion in mortgage securities.

While the growth in mortgage securities has been significant, JPMorgan analysts said in the report, bank residential (one to four family) loan holdings grew by $215 billion to $1.4 trillion. This is compared with growth of $122 billion in 2005. Analysts pointed out that some of this surge in loans last year was a result of mergers. Still, analysts expect that overall, banks will remain holders of mortgages though future purchases are anticipated to be weighted more toward loans versus securities. This fact seems to find support in recent data that showed MBS growing at a 5% year-over-year pace versus an 18% pace for real estate loans.

Since the third quarter, analysts pointed out the most notable changes were from Capital One and Regions Financial. These banks increased their MBS shares by 16% and 11%, respectively, to 74% and 71%, while Fifth Third downsized its MBS allocations by 10% to 77% of its total portfolio size.

On the deposit side, deposits increased 7% quarter over quarter. Analysts said this was the largest quarterly growth of core deposits seen in recent years. For example, Capital One experienced a 115% jump in the fourth quarter compared with the third quarter, and Regions had a 60% gain. Also experiencing a large percentage increase was Citigroup at 51%. Increases were generally a result of mergers. On average, bank MBS holdings as a percent of total deposits was around 21%, analysts said.

Bank net interest margins were pressured last quarter as their funding costs rose more than asset yields. On average, margins in 2006 fell 20 basis points to 3.3% from 3.5%, the lowest annual average since 1988, according to Federal Deposit Insurance Corp. data. JPMorgan analysts believe that as NIMs continue to drift lower that banks could slowly start to unload lower coupon securities and move into higher coupon MBS or into whole loans.

Other highlights from the top 25 banks in the fourth quarter were an 8% increase in GNMA holdings and a 16% increase in non-agency passthrough holdings. Agency CMO holdings declined 3% while non-agency CMO holdings jumped 13%. Citigroup was the largest buyer in CMOs, focusing totally in non-agencies.

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