Mortgages have benefited from strong bank demand in 2006. Through the first half of this year, MBS holdings at large U.S. banks surged to $67 billion, compared to $35 billion for all of 2005, according to a recent report from Credit Suisse analysts. They add that so far in 3Q06, large banks have already recorded a $14 billion growth in MBS holdings.

The driving forces for this sponsorship include excess liquidity brought on by strong deposit growth; strong capital ratios, which have forced banks to deploy liquidity to boost earnings; and reasonable ROE on MBS, Credit Suisse analysts said. They expect banks will remain buyers of MBS as long as these factors remain in place. At the same time, strong selling is not anticipated given that unrecognized losses on available-for-sale holdings is at a record high. Should the selling occur, analysts believe it would coincide with "a prized acquisition or with the sale of assets with embedded unrealized gains, thereby offering an opportunity for a balance sheet restructuring," analysts wrote.

The report also discusses factors that would cause banks to limit their buying, including the slowing of deposit growth driven by corporate re-leveraging and declining home equity extraction. Analysts also estimate that a 50 basis point flattening between the current coupon MBS and Libor (which they equate the projected ROE on MBS to that offered by share buybacks) would erode the relative attractiveness that MBS offer.

While the outlook appears favorable for continued bank buying, JPMorgan Securities analysts note that historical data shows that MBS holdings don't tend to grow during the third quarter. Looking at the period 2003 to 2006, JPMorgan analysts observed that MBS growth tends to be focused in the first quarter and is negative in the third quarter. This trend was observed for both large and small banks. Looking at a longer period - 2000 to 2006- the largest growth was observed in the first and fourth quarters, and was flat in the third quarter for large banks. For small banks, the first quarter saw the strongest growth, while quarter three - though positive - showed the slowest growth in MBS holdings.

JPMorgan analysts also observed that for large banks, the third quarter tended to show the strongest growth in mortgage holdings. For small banks, mortgage loan growth appeared more balanced throughout the year.

(c) 2006 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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