The Federal Reserve‘s monetary tightening policy and the recent banking crisis have the potential to change the mortgage-backed securities (MBS) market’s dynamics more than anything seen over the last two decades, according to secondary market experts.
The Fed and U.S. banks, which glommed onto these assets in the wake of the Global Financial Crisis, are expected to play a smaller role in the years to come. They are likely to be replaced by money managers as investors. Meanwhile, with the primary market struggling amid higher rates and lower inventory, MBS supply is expected to decline.
Several market experts discussed these topics during the Mortgage Bankers Association (MBA) Secondary and Capital Markets Conference and Expo 2023 in New York.
The buyers’ side
Steven Abrahams, a senior managing director at Amherst Pierpont Securities, a broker-dealer owned by Santander, said that before the Global Financial Crisis, the market was dominated by investment portfolios looking for the risk and return of MBS assets.
However, after the crisis, the Fed entered the MBS market, and new regulations encouraged banks to hold quality liquid assets, including MBS.
“What we’re looking at now is the initial phase of exit of those two policy investors and the return of the market to marginal pricing by portfolios that are in the game basically to make money,” Abrahams explained. “That’s the easiest way to think about why spreads have widened the way they have.”
Byron Boston, CEO and co-chief investment officer at Dynex Capital, Inc., said that “levered returns are very attractive today” and there’s a “huge demand for income,” which will keep MBS attractive to money managers.
“A 30-year fixed rate mortgage is an unusual beast,” Boston said. “But because our government is involved with it, all of us as American citizens have the pleasure of having it.”
The sellers’ side
As affordability is still an issue, originations will decline and affect the supply of MBS, panelists said. The MBA estimates that volumes will decline from the $4 trillion level in 2020 and 2021 to less than $1.8 trillion this year.
According to Jeana Curro, head of agency MBS research at Bank of America, mortgage rates are still very high and people that have walked into very low mortgage rates during the pandemic “are kind of stuck in their homes.”
“We’re forecasting about $268 billion a year in [MBS] net issuance. Last year, it was about $535 billion,” Curro said.
The secondary market experts have not seen any disruptions caused by the sale of MBS securities once held by banks that collapsed.
The Federal Deposit Insurance Corporation (FDIC) decided in early April to sell the $114 billion in MBS it retained after seizing control of failed regional banks Signature Bank and Silicon Valley Bank (SVB). BlackRock Financial Market Advisory has led the sales process.
Curro said that BlackRock has been smart in its executing a strategy that keep the size of offerings low and consistent while also actively communicating with the market.
“The bigger disruption that you want to be concerned about, beyond the mortgage market, is that we’re doing this within a global system that has an enormous amount of risk attached to it,” Boston said. “If you have another risk event that takes place on top of this – while we’re trying to clear the market of the banking problem – now we have a bigger issue.”
Boston added: “These are really good assets. It’s just a matter of what price ultimately will come about.”
Regarding the Fed’s MBS portfolio, Curro said that “We think what’s more likely to happen, and this is the Bank of America economist’s view, is that by the end of the first quarter of 2024, QT [quantitative tightening] is going to end and at that point, what they’re likely to do is take the mortgage pay downs and reinvest them into Treasuries.”