Investors are holding back from the $11tn US mortgage-backed securities market because of uncertainty over how regulators plan to dispose of the roughly $91bn portfolio they acquired from the collapses of Silicon Valley Bank and Signature Bank.
Falls in the value of SVB’s vast MBS portfolio over the past year as interest rates rose were a significant factor in spurring the bank run last month that led to the second-largest bank failure in US history.
Analysts calculate that the US Federal Deposit Insurance Corporation now holds some $69bn in MBS from SVB with another $22bn from Signature, based on fourth-quarter earnings reports. Once holdings of other bonds such as Treasuries, municipal debt and commercial MBS are included, the FDIC has $120bn to liquidate.
“Most investors that we’ve spoken to . . . agree that mortgages look fundamentally attractive, but the uncertainty regarding the approach and timing to the sales has many investors waiting to increase [allocations],” said JPMorgan analyst John Sim in a note to clients.
The FDIC announced plans on Monday to market a $60bn Signature Bank loan portfolio, mostly made up of commercial real estate debt, but has remained tight-lipped about its securities holdings. The FDIC declined to comment on its plans.
The challenge for the FDIC will be maximising value from any sale, which comes at a tricky time for the MBS market. Prices have been hurt over the past year by a combination of rising interest rates as well as by volatile moves in US Treasuries, whose yields, reflecting the interest they pay, stand as a reference guide for mortgage bonds.
While the exact holdings of the collapsed banks are not known, analysts believe the bulk is heavily weighted to bonds sold before interest rates and bond yields rose, meaning they are likely to carry lower coupons of perhaps 2 to 2.5 per cent. While accounting rules allowed the banks to avoid recognising losses on most of those bonds, their prices have fallen much further than more recently issued MBS that offer yields above 6 per cent.
Anticipation of the FDIC’s sales have already hit prices. The extra yield, or spread, demanded to hold securities with 2 and 2.5 per cent coupons has widened by between 0.18 and 0.27 percentage points more than the equivalent Treasuries over the past month, according to Bank of America analysts. By contrast, that spread for bonds with coupons of 6 or 6.5 per cent has narrowed by up to 0.19 percentage points.
Regulators will also be aware that supply is a hot topic in the fragile MBS market, which swooned last summer on fears that the US Federal Reserve would begin to sell down its holdings and only steadied after an assurance by chair Jay Powell that bulk sales were not imminent.
“The FDIC has political considerations here as well as financial,” said Kirill Krylov, MBS portfolio strategist at Baird. “If they sell to a few big bidders, they can be accused of favouring big institutions. If they drag out the sales over months, then they’ll incur extra hedging and trading costs and efforts.”
Analysts said the closest precedent was the 2008 collapse of mortgage-focused bank IndyMac. Then, the FDIC offloaded its holdings after rounds of bidding, which duly attracted criticism that it had favoured large buyers and, as a result, may not have got the best price.
BofA analysts calculated that selling between $3bn and $6bn each week would equate to between one and three days’ worth of supply for the market. At that rate offloading would take the FDIC between three and eight months.
“There is nothing we see forcing a sale, and in fact, FDIC is mandated to maximise value when winding down assets, which to us implies a gradual pace and modestly sized transactions,” they wrote to clients.
Gradual sales, however, still carry risks, since the value of the bonds could fall further in that time. While a recovery in prices is also possible — particularly if the Fed has almost finished raising interest rates as investors currently believe — it isn’t a risk-free option for the regulators.
“If they acknowledge they decided to keep them to benefit from a macro trend, it could cause a political headache,” said Baird’s Krylov.
He offered a third suggestion, whereby the FDIC would sell a chunk — perhaps between one-quarter and half the portfolio — to gauge the market appetite, before deciding how to dispose of the rest.
“We don’t know for sure how the market would react and this way, they get to see,” he said. “If it chokes, then they can go slow and steady after, but they’ve cut their risk.”
Throughout, the Fed will be watching the process closely, not least because the FDIC’s newly acquired portfolio is similar to the make-up of the Fed’s $2tn-odd holdings, analysts believe, and could provide clues for any future sales.
“This exercise will certainly be studied as a microcosm of what impact Fed sales — if they ever were to occur — could have on the MBS market,” said JPMorgan’s Sim. “We don’t think the Fed is contemplating sales in the near term — Powell has made that point repeatedly. That discussion is for much farther down the line.”
