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Mortgages: Is bank demand sustainable?

In this morning’s research, Lehman Brothers said banks purchased roughly $100 billion worth of mortgages in February, one of the largest months of purchases historically. The rise is in line with the growth in bank equity and assets, and is probably a one-time event, Lehman said.

Banks had been on the sidelines in December and January. According to the Fed’s weekly survey on assets and liabilities of commercial banks, MBS holdings in the form of securities increased by over $80 billion in February. For the year, MBS holdings have increased by roughly $86 billion.

From December, total bank assets have grown by a remarkable pace of $230 billion, versus a total increase of $370 billion in 2003. Meanwhile, bank deposits have only grown $15 billion. This shows that most of the rise in assets is due to increased borrowings. Bank real estate lending has risen by $26 billion. On the other hand, C&I lending has been flat. In fact, C&I actually decreased by $0.1 billion.

Lehman is concerned by the lack of growth in deposit activity. Borrowing and buying mortgages as a way to increase net interest income may continue to be a strategy until the Fed moves to a tightening bias, Lehman said.

However, if the increased borrowing is motivated by capitalization levels, it could be a one-time event. In a span of a year, the equity portion of bank balance sheets has grown $26 billion. The $230 billion rise in bank borrowings and assets is in line with the equity to assets ratio of approximately 9%, which banks have maintained over the last couple of years.

The rise in equity seen in the first two months of the year is probably a reflection of strong earnings from last year. Unless the equity portion of bank balance sheets continues to grow significantly, Lehman said it is unlikely that the level of February purchases will be repeated any time soon.

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