By Jason W. Smith
After failures at SVB and Signature, markets have successfully absorbed vast sales of the banks’ MBS portfolios.
Coming into 2023, the agency mortgage-backed securities market seemed likely to benefit from both higher mortgage rates and the impact of sizable refinancings in 2020-21, leading to lower forecasts for new origination supply this year.
This has largely played out as expected, with a modest $93 billion in net origination through midyear compared to annual average of $650 billion over the past three years.
Given that money managers and other relative value investors were expected to be the source of marginal demand in 2023, supply levels should have been very digestible.
However, the market endured a unique shock in April, when it was announced that some $83 billion in MBS seized by the FDIC from SVB and Signature Bank (OTCPK:SBNY) were to be sold back into the market in a “gradual and orderly” manner.
The bonds typically would have stayed on bank balance sheets but were being reintroduced into available float. The announcement greatly widen spreads for Agency MBS given the uncertainty created by the size and speed of the planned liquidation.
Interestingly, the makeup of the bonds is quite different than that of current higher coupon MBS otherwise being issued into the markets. These were low-coupon securities originated in 2020–21 that at the time were largely purchased for bank and Federal Reserve balance sheets. More significantly for investors, the bonds, which had originated at prices north of par, came to trade at a 15 to 20% discount to par.
After some initial uncertainty, however, the market has quickly turned the recent liquidation event into an opportunity. Two-and-a-half months into the selling program, the FDIC has already shed about 68% of the two banks’ pass-through securities and 50% of their collateralized mortgage obligations.
Meanwhile, markets have already bid up spreads by about 15 basis points. Given the healthy demand and orderly market absorption, the selling program is expected to finish well ahead of most initial expectations.
Looking back to the start of the year, one of the opportunities we saw in the Agency MBS landscape was the potential to invest at a discount – a rare occurrence for a market that historically has traded at prices of $103 and above. We were not expecting the degree of the recent opportunity, but so far the FDIC has cooperated nicely with our views.
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