The market volatility triggered by the failure of three banks in the past week has spooked traders in economically vital US mortgage-backed securities, leaving other lenders, usually important buyers, on the sidelines.
The $11tn market for bundles of US home loans was already feeling the strain of last year’s soaring interest rates, which pushed up MBS spreads — the additional yield over risk-free US Treasuries that investors demand to hold mortgage debt — even faster.
These spreads have increased from 1.1 percentage points to 1.6 points in the past year.
That in turn forced up mortgage rates and helped lower new home purchase applications in February to their lowest level in more than 20 years. Housing — including investment, rents and other services — accounts for roughly a sixth of the US economy.
Big swings in stock as well as bond markets this week followed the news on Sunday of regulators’ takeover of New York-based Signature Bank. Four days earlier, crypto-focused Silvergate had voluntarily put itself into liquidation.
On Monday, the combination of plunging bank stocks and a dash for the safety of government bonds led Fannie Mae, a Washington-backed home loan body and important source of so-called agency, or government-sponsored, MBS, to postpone its own sale of about $500mn in bonds.
Fannie Mae’s pause followed the key event for the mortgage market, namely the collapse on Friday of Silicon Valley Bank. This came after a botched capital raise following its $1.8bn loss on the sale of a $21bn asset portfolio that included top-rated MBS — a deal that shone a spotlight on the fragile state of the mortgage world.
Banks hold government-backed MBS alongside Treasuries as assets that can be sold easily when cash is needed. The low-yield environment that existed until last year lured them to invest more in mortgage-backed securities because they offered slightly better returns than straight government bonds but were still considered safe.
The hit taken by SVB on its sale has sparked fears that other lenders coping with sudden outflows could be forced to dump their MBS on the market and suffer even greater losses, potentially swamping an already-weak ecosystem.
On Sunday evening, the Federal Reserve announced a new facility to lend to banks against their liquid assets, including MBS. Although the loans will be made at the par, or face, value of the assets, not the lower prices to be found in the markets, the scheme was not expected to stabilise the market overnight.
“This year we had a delicate balance of the Fed winding down [its portfolio], money managers buying more and we expected to see banks coming back and buying perhaps $100bn slowly, but that’s just not happening,” said John Sim, securitised products research analyst at JPMorgan Chase.
Last year, the Fed began allowing its portfolio of more than $2tn in MBS to run off: that is, it has not replaced bonds as they are repaid. But, in a nod to the market’s precarious state, it held back from selling bonds outright. It had begun accumulating MBS as part of its efforts to stabilise markets following the 2008 financial crisis and at its peak last year, held roughly a quarter of the total outstanding.
This week’s volatility, however, has made market followers wonder if it will halt even its modest run-off policy. Sim said it was his clients’ most often-asked question this week.
“It definitely doesn’t feel that they would do that right away, but if you continue to see this market pain, there’s the potential for them to put that back on the table,” he added
Beyond the current ructions, analysts said the key factor in any sustained market recovery was a clear drop in volatility.
The ICE Bank of America Move index of bond market volatility this week spiked far above its early 2020 pandemic peak to hit its highest level since the 2008 financial crisis — even though investors so far have swung sharply from pricing in further painful interest rate rises to betting that banks’ woes will force central banks to speedily lower rates.
“Even as the market reprices lower, we are seeing an increase in rates volatility and [government-backed] MBS doesn’t like that,” said Lotfi Karoui, chief credit strategist at Goldman Sachs. “When volatility goes up, the ability of MBS investors to deploy extra capital is constrained.”
In a note last week, Karoui and his team highlighted that MBS issuance this year was running at its lowest level since 2001, which could help boost prices and lure in buyers once markets have stabilised.
That can’t come soon enough for struggling homebuilders and those homeowners unable to move because of the jump in borrowing costs they would face on a new loan compared with their existing fixed-rate deal set when rates were much lower. But the market mood following this week’s price action suggests “soon” is still likely to take a while.