While many sectors of the debt capital markets have matched last year's new issuance totals, the mortgage-backed securities market has quietly gone about the business of imploding.
For the first nine months of 2000, MBS new issuance is down by 55% from the same year-ago period, and only $111.9 billion in new mortgage bonds have been issued compared with the $249.6 billion posted by this time in 1999, according to preliminary data from Thomson Financial Securities Data.
Indeed, even the market's top underwriters, such as Lehman Brothers, Credit Suisse First Boston and Salomon Smith Barney, are posting severely reduced issuance totals compared with last year. Top MBS underwriter Lehman has brought $18.3 billion in new MBS to market in the first three quarters of 2000, a 46% drop from the $34 billion the shop had underwritten by the end of third quarter 1999.
Perhaps the most catastrophic drops came from middle-tier players like PaineWebber, which went from $22.2 billion in 1999 to $5 billion as of last week, and Bear Stearns & Co., whose underwritings have fallen roughly 67% so far in 2000. Given the slim margins in the MBS business even in its heyday, the big chill of 2000 has left Street players wary, trimming both their participation and deal sizes.
Earlier this year, observers pinned the market's underperformance on the broader malaise in debt capital markets. As 2000 progressed, however, sectors ranging from investment-grade to municipals returned to the pink of health, while MBS stayed bedridden. Even the asset-backed securities sector, which sometimes shares the same characteristics and investors as MBS, has had almost the same issuance rate as in 1999.
Why the Swoon?
Market pros said that the MBS market is now reaping the effects of a number of ill developments, in some cases extending back as far as the 1990 recession. Many factors have helped hobble the sector so far this year, including high interest rates and the mergers and collapses of many of the MBS market's former players.
"We were dealing with high rates and an inverted Treasury curve," among other factors, said Brian Harris, an executive director in the principal finance group at UBS Warburg. "When you add them all up it wasn't good for the market."
Low mortgage rates lead to high numbers of refinancings, which flood new supply into the MBS market. Since much of 1998 and 1999 saw interest rates below 6%, in some cases falling below 5.50%, the mortgage bond market had a ripe season of potential new issuance. A series of Federal Reserve interest rate tightenings earlier this year killed that opportunity.
The market took a number of other blows at approximately the same time. Volatility was plaguing the market in early 2000, as the Treasury curve inversion threw spreads out of whack. Top issuers Freddie Mac and Fannie Mae were blasted by Congress and the Wall Street Journal, prompting rumors of charter revisions or privatizations. And a wave of subprime lender collapses greatly reduced the number of players.
To make things worse, while the market could normally expect a number of 10-year mortgages to expire, prompting a wave of refinancing or new mortgage issuance, the 1990 recession meant that a far lesser number of mortgages had been issued in that period. Many lenders also closed up shop in the latter months of 1999 in fear of the Y2K crisis, further reducing the supply of loans.
The situation has made a number of Street shops wary of committing capital to the mortgage market. Where two years ago, firms like Goldman Sachs, Salomon and Nomura Securities were pushing multi-billion securities into the residential and commercial MBS market, the average Street strategy of 2000 has been decidedly more small-scale.
"If you needed a loan below $15 million you got 15 bids," said one pro. "But if you need a loan above $20 million you couldn't find a bid."
The reduction began after the mortgage market closed down in late 1998 and a number of Street players wound up suffering losses for holding too many poor-performing mortgage loans. "After October 1998, people became hesitant to carry larger inventories," UBS' Harris said.
UBS said that competition was so fierce for the smaller end of the market that they began lending in larger amounts and offering larger-scale deals simply as a competitive strategy. UBS and Lehman Brothers have co-lead managed the largest CMBS deals so far this year.
There are signs that the mortgage market is at last regaining its footing. The upcoming election likely means that the Fed will be on the sidelines for months, giving the market some breathing room, and swap spread volatility seems to have abated. Insiders say that the market could still pull off a vibrant fourth quarter.
But veteran pros said that when the mortgage market goes bad, it goes very bad, and some remain unconvinced that the troubles are fully over.