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Who owns all these 30 year mortgages at low rates?


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Who owns all these 30 year mortgages at low rates?  I was reading Liar's Poker and Michael Lewis was discussing banks selling mortgages at well less than par (65 - 80 cents) because mortgage rates had gone up the early 1980's.  One can easily imagine a scenario where mortgage rates go up to 7.5% or much higher and the market price of mortgages declines drastically.  Seems like a very risky and dangerous bet to be holding these long term mortgages. 

 

Historical Mortgage rate chart

http://research.stlouisfed.org/fred2/graph/?g=NUh

 

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A lot of them are owned by foreign governments like Japan and China.  Then you have insurance companies and pension funds, etc...  Even Berkshire - which obviously knows they are a lousy investment - owns $1.75 Billion worth (not counting the Clayton loans).

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From memory (the order may be wrong)

 

1. The Fed (you know that whole QE thing)

2. Banks

3. Overseas

4. Mortgage REITs (these are the most levered and sensitive)

5. Everyone else

 

You can google around for the exact percentages. While they are certainly very risky, I think it's important to remember that the weighted average life of a 30 yr amortizing mortgage is about 18 yrs and that is assuming full extension to 30 yrs.

 

Because people move, die, get divorced, etc. the average amount of time an individual mortgage is outstanding is closer to 10 yrs I believe.

 

I don't mean to dismiss the risk. They are high duration, negatively convex, hard to hedge pieces of paper. But it's not as if they are actually 30 yr bonds. amort and prepayments shorten the life and duration significantly.

 

 

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I ran some stats on these recently.  Banks in general do not own much longer than 10 years on their own balance sheets.  I believe the longest products are sold to the government and packaged into securities.  Banks might be the buyers of some of those securities, but I don't know who else owns them.

 

Recently I pulled some stats for a Bloomberg article (http://www.bloomberg.com/news/articles/2015-02-23/bofa-leads-charge-into-bonds-as-banks-build-2-trillion-hoard) showing the difference between Treasury and Agency holdings at the largest banks in the US.  If anyone's interested I can run another query showing Treasury/Agency (including MBS) at banks, but in short most banks own a LOT of MBS.

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to be clear, I'm referring to Agency MBS. Banks still own a lot of them.

 

It's the largest, most liquid fixed income product in the world after treasuries. Everyone who's anyone owns them.

 

Just a quick glance

 

Wells Fargo    114B

BoA              180B

 

I doubt there are many people who own the bond index or whatever, but I would just point out that 28% of the Lehman Agg is is MBS pass thru's.

 

Not all of them are 30 yrs of course. But everyone who has a big bond book owns agency MBS. You can't not own MBS if you are a large insurance company, bank, etc.

 

But I would point out that the Fed was vacuuming in a huge chunk of new issuance for the past several years so it's not like wherever you see MBS it means super high duration low return negatively convex  30 yr 3.5% pass thru. It could be dwarfs (15 yrs) or high  loan balance seasoned ones with high coupons and burned out borrowers. It could be 5/1 ARMs or this or that.  It could mean a lot of different things.

 

 

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While everyone is nervous about long rate exposure on these mortgages, you have to ask yourself what happens if you are wrong and rates continue lower.

 

Big pension plans and other buyers who need a certain level of income basically have no choice but to buy and hold.  You can't run the risk of rates moving down while you're sitting earning close to zero.  To those buyers, interest rate risk is a lot less punishing than being even more underfunded.

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Because people move, die, get divorced, etc. the average amount of time an individual mortgage is outstanding is closer to 10 yrs I believe.

 

 

The other reason people pay off their mortgages is to refinance it, either to take cash out or to lower their interest rate. I think I remember reading somewhere that the average life of a mortgage was around 5-7 years, the first thing I found with a google search says 3-5 years.  I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates.  In a rising rate environment people would not refinance as often.

 

"The average life of a mortgage is just three to five years, estimates Douglas Duncan , chief economist at the Mortgage Bankers Association of America."

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Because people move, die, get divorced, etc. the average amount of time an individual mortgage is outstanding is closer to 10 yrs I believe.

I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates.  In a rising rate environment people would not refinance as often.

 

Amen Brother! Negative convexity at work. Increasing duration when you don't want it (rates rising) and decreasing duration when you don't want it (rates falling).

 

I forget who said it but the no prepayment penalty fixed rate 30 yr mortgage "would not exist in nature". all the optionality is in the borrower's hands.

 

Another way to prepay is to default.

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Something else to keep in mind.  The agencies are supposed to be wound down by 2018 leaving no one to buy these mortgages.  Saw an article recently saying that no bank would hold a 30-yr mortgage on their books.  Maybe by 2018 we'll start to see Canadian or European mortgage products.  Or a race to the deadline with house sales going like crazy with everyone trying to lock in financing before these mortgages vanish.

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Because people move, die, get divorced, etc. the average amount of time an individual mortgage is outstanding is closer to 10 yrs I believe.

I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates.  In a rising rate environment people would not refinance as often.

 

Amen Brother! Negative convexity at work. Increasing duration when you don't want it (rates rising) and decreasing duration when you don't want it (rates falling).

 

I forget who said it but the no prepayment penalty fixed rate 30 yr mortgage "would not exist in nature". all the optionality is in the borrower's hands.

 

Another way to prepay is to default.

 

I agree.  But even if the no prepayment penalty 30 year fixed rate mortgage has to exist because of government regulations, I always wondered why there wasn't an enormous difference in rates between the fixed rate products and the ARMs?  You would think the market would set the rates in general and on average to make all types of mortgages an equally attractive deal to both the buyers and the sellers.  It seems to me that the fixed rate mortgages are always cheap compared with the ARMs (unless you know for sure that you will have the mortgage less than 7-8 years), which leads me to think that some form of government regulation is also involved somewhere in skewing the rates in an unnatural direction to the consumers benefit.

 

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Because people move, die, get divorced, etc. the average amount of time an individual mortgage is outstanding is closer to 10 yrs I believe.

I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates.  In a rising rate environment people would not refinance as often.

 

Amen Brother! Negative convexity at work. Increasing duration when you don't want it (rates rising) and decreasing duration when you don't want it (rates falling).

 

I forget who said it but the no prepayment penalty fixed rate 30 yr mortgage "would not exist in nature". all the optionality is in the borrower's hands.

 

Another way to prepay is to default.

 

I agree.  But even if the no prepayment penalty 30 year fixed rate mortgage has to exist because of government regulations, I always wondered why there wasn't an enormous difference in rates between the fixed rate products and the ARMs?  You would think the market would set the rates in general and on average to make all types of mortgages an equally attractive deal to both the buyers and the sellers.  It seems to me that the fixed rate mortgages are always cheap compared with the ARMs (unless you know for sure that you will have the mortgage less than 7-8 years), which leads me to think that some form of government regulation is also involved somewhere in skewing the rates in an unnatural direction to the consumers benefit.

 

empirical studies show that most people are better off taking the floating rate, actually (I'm once again spouting generalizations from memory, feel free to fact check this).

 

What free market? A non-economic buyer has been waving in the issuance coupon for the past 3 yrs. The Fed is the one who loves buying 30 yr maturity mortgages at 3% coupons after g+s fees. It's huge stimulus. 

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Because people move, die, get divorced, etc. the average amount of time an individual mortgage is outstanding is closer to 10 yrs I believe.

I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates.  In a rising rate environment people would not refinance as often.

 

Amen Brother! Negative convexity at work. Increasing duration when you don't want it (rates rising) and decreasing duration when you don't want it (rates falling).

 

I forget who said it but the no prepayment penalty fixed rate 30 yr mortgage "would not exist in nature". all the optionality is in the borrower's hands.

 

Another way to prepay is to default.

 

I agree.  But even if the no prepayment penalty 30 year fixed rate mortgage has to exist because of government regulations, I always wondered why there wasn't an enormous difference in rates between the fixed rate products and the ARMs?  You would think the market would set the rates in general and on average to make all types of mortgages an equally attractive deal to both the buyers and the sellers.  It seems to me that the fixed rate mortgages are always cheap compared with the ARMs (unless you know for sure that you will have the mortgage less than 7-8 years), which leads me to think that some form of government regulation is also involved somewhere in skewing the rates in an unnatural direction to the consumers benefit.

 

empirical studies show that most people are better off taking the floating rate, actually (I'm once again spouting generalizations from memory, feel free to fact check this).

 

What free market? A non-economic buyer has been waving in the issuance coupon for the past 3 yrs. The Fed is the one who loves buying 30 yr maturity mortgages at 3% coupons after g+s fees. It's huge stimulus. 

 

I suppose that would be the case if the average mortgage is ~5 years.  For the person who intends to hold the mortgage to maturity or until rates drop enough to make refinancing worth it, the 30 year fixed rate mortgage is an an incredible deal.

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Something else to keep in mind.  The agencies are supposed to be wound down by 2018 leaving no one to buy these mortgages.  Saw an article recently saying that no bank would hold a 30-yr mortgage on their books.  Maybe by 2018 we'll start to see Canadian or European mortgage products.  Or a race to the deadline with house sales going like crazy with everyone trying to lock in financing before these mortgages vanish.

 

Seems to me the political ramifications of 30 year mortgages going away means that the government will find a way to continue their existence. I bet a large percentage of the people buying homes would be unable to afford them if they were forced into shorter term loans.

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Because people move, die, get divorced, etc. the average amount of time an individual mortgage is outstanding is closer to 10 yrs I believe.

I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates.  In a rising rate environment people would not refinance as often.

 

Amen Brother! Negative convexity at work. Increasing duration when you don't want it (rates rising) and decreasing duration when you don't want it (rates falling).

 

I forget who said it but the no prepayment penalty fixed rate 30 yr mortgage "would not exist in nature". all the optionality is in the borrower's hands.

 

Another way to prepay is to default.

 

I agree.  But even if the no prepayment penalty 30 year fixed rate mortgage has to exist because of government regulations, I always wondered why there wasn't an enormous difference in rates between the fixed rate products and the ARMs?  You would think the market would set the rates in general and on average to make all types of mortgages an equally attractive deal to both the buyers and the sellers.  It seems to me that the fixed rate mortgages are always cheap compared with the ARMs (unless you know for sure that you will have the mortgage less than 7-8 years), which leads me to think that some form of government regulation is also involved somewhere in skewing the rates in an unnatural direction to the consumers benefit.

 

One reason can also be that the ARMs aren't fully floating. From my experience, you still have an absolute cap, (like 500 BPS above the starting rate ) so it's really not as risky as some might initially think.

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Because people move, die, get divorced, etc. the average amount of time an individual mortgage is outstanding is closer to 10 yrs I believe.

I suspect mortgages last longer when the general trend is rising rates and shorter when the trend is decreasing rates.  In a rising rate environment people would not refinance as often.

 

Amen Brother! Negative convexity at work. Increasing duration when you don't want it (rates rising) and decreasing duration when you don't want it (rates falling).

 

I forget who said it but the no prepayment penalty fixed rate 30 yr mortgage "would not exist in nature". all the optionality is in the borrower's hands.

 

Another way to prepay is to default.

 

I agree.  But even if the no prepayment penalty 30 year fixed rate mortgage has to exist because of government regulations, I always wondered why there wasn't an enormous difference in rates between the fixed rate products and the ARMs?  You would think the market would set the rates in general and on average to make all types of mortgages an equally attractive deal to both the buyers and the sellers.  It seems to me that the fixed rate mortgages are always cheap compared with the ARMs (unless you know for sure that you will have the mortgage less than 7-8 years), which leads me to think that some form of government regulation is also involved somewhere in skewing the rates in an unnatural direction to the consumers benefit.

 

the reason that there is not a huge variance between fixed and floating is that would imply too large of a spread between the  treasuries and agency debentures and agency MBS. these are government sponsored entity (basically govt guaranteed and actually full faith and credit in the case of ginnie mae) guaranteed cash flows deserving of a no credit spread.

 

So the spread is to compensate for prepayment volatility and weighted average life variability of being short the prepayment option and rates vol. To have fixed mortgage rates well in excess of long term treasuries would allow for an arbitrage where you could buy MBS and hedge out some of your rate vol with payer swaps and swaptions and earn a shit ton of excess carry particularly on a levered basis (which you can get hefty leverage on Agency MBS because it's super liquid and has no credit risk, with the exception that defaults are prepayments so they are a risk if you pay high premiums to par).

 

Now spreads on pass thru's have been very low relative to their history lately, but that's because the fed having a virtually unlimited bid.

 

i haven't been an mortgage bond trader for almost 2 yrs now (and was only one for a couple years), and I was not an agency pass through trader (was on a different side of the floor) so I'm not up on my mortgage bases and where things trade so I'm a little rusty here.

 

But in general, there is a place in the fixed income world for this paper. Now I'm not sure if there is a natural buyer for 3% 30 yr's, but the Fed is the bagholder there, for the most part. And things like AGNC. But as rates move up, it will once again make sense for a broader swath of the fixed income community to own plain old agency MBS.

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not really...my 2 yrs as a trader ON ANOTHER PART OF THE FLOOR certainly did not make me an expert by any means. I have a very basic internship+training program+needed to know a little bit of knowledge beyond my very silo'd area. I left because I had read Security Analysis twice before getting through a chapter of Fabozzi. Clearly my passions were elsewhere.

 

I view agency mREITs as just a way of getting levered long duration and short rate and prepayment volatility; you are also playing the steepness of the yield curve. I don't have a view on what the right multiple of book to pay is because even though many of them have de- levered and de-rated, these are still pretty levered vehicles. I view them as publicly traded trading desks; at the right discount, I see them as efficient ways of getting long bonds and earn high carry by taking those risks.

 

My only impression of AGNC versus other REITs is that AGNC sticks to Agencies and buys further out on the curve than most (takes more duration and extension risk), whereas others have tried to focus on other areas (non-agency, 15 yr's, IO's, ARMs, etc.) to try to diversify away from the big extension risk and very negatively convex on the run low coupon 30 yr securities. My impression could be totally wrong and outdated. 

 

I hope AGNC does well so it can drive fees to ACAS but that's another story.

 

Sometimes I buy mREIT preferreds (December 2013 several were available at 80% of par and 7-9% yields, made for a good ~30% TR as taper tantrum fears abated over 2014) and REIT preferreds in general. I like those because you can get 8+% carry plus yield compression optionality in exchange for insuring blow-up risk. Illiquid and retail owned = decent trading opportunities.

 

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thanks.  you may not think of yourself as an expert, but everything is relative.  you're far more informed than am i, so in relative terms, you offer very useful thoughts.

 

i don't think your views on agnc are outdated, if anything they currently seem to be even more willing to take on duration, while the others (at least nly, i guess i never really pay attention to any others besides those two) are doing everything to avoid it.

 

your mention of the preferreds is interesting.  the last time the price to book of the common was around this level was december 2013.  i should check and see if the preferreds have declined along with the common (my guess is probably not, but worth checking).

 

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