This week’s attempt by the FDIC (Federal Deposit Insurance Corp.) to sell securities backed by residential mortgages and construction loans marks a huge milestone in the road back to normalcy for the financial markets this week. Let’s hope the markets pass the test.
The FDIC has bundled together some of the mortgages and loans it owns after taking over failed banks into a mortgage-backed security of the kind that was the mainstay of the mortgage market before the financial crisis.
That market has been essentially closed for new business since the crisis with only Fannie Mae (FNM) and Freddie Mac (FRE) willing to buy these securities with funds provided by taxpayers. Banks use this market to sell mortgages that they have originated so they can put the proceeds back into new mortgages. When this market is frozen, banks have to hold onto the mortgages they’ve originated and that reduces the money they have available for new mortgages. If banks know they can’t securitize and sell their mortgages, they become more reluctant to lend. And that reduces the availability of mortgages.
Because private investors haven’t been willing to buy these securities post-crisis, taxpayers through Fannie Mae and Freddie have been left as the only buyers. That’s been necessary to keep the market functioning at all, but Fannie and Freddie can’t keep expanding their books forever. At some point private investors need to step back into this market.
The mortgage-backed securities that the FDIC will offer for sale this week are designed to entice private investors back into the market.
The expected interest rate is 0.9 to 0.95 percentage points above the yield on U.S. Treasuries for the fixed-rate portion of the offering.
But it’s not the interest rate that’s the biggest inducement. This offering—the first is for $1.8 billion-comes with a government guarantee. The hope is that will be enough to get private investors to buy.
Of course, if the deal sells taxpayers won’t really be off the hook. The mortgages and loans will be off taxpayers’ books at the FDIC. But the securities will still be backed by taxpayers.  It’s taxpayer money, after all, that stands behind the guarantee.
So call this a half step back to normalcy for the mortgage-backed securities market.
But remember that the 10,000 mile journey to normalcy begins with a half step.
If, that is, the offering sells.
@Javos
The premium on the FDIC offering is probably because they are new. The Treasury market is large and very liquid, but there is no such market for the FDIC offerings.
Yes, there is cash flow. These are bonds.
This has less to do with taxpayers and more to do with FDIC fund solvency. Obviously, the FDIC needs to get cash to cover bank failures from somewhere. They liquidate assets from failed banks, but there’s a cost (hence the FDIC insurance premiums banks pay). They’re trying this new sales strategy as a way to get rid of the troubled assets they’re holding.
Can NLY keep up the high yield? Maybe. This depends on where interest rates go and on their leverage ratio. Basically, they borrow short in the repo market and invest long in GSE guaranteed MBS’s.
Right now they’re spending around $.30/share/quarter to hedge against rising long term rates. Without that hedge they’d be able to pay another ($1.20/year) / $18/share = another 6.67% dividend yield.
If short term rates rise then their spread will be lowered, unless long term rates rise in tandem or faster. However, if long term rates rise then they lose money on asset value (hence the huge hedge and adj. rate book). So, the optimal scenario is just what we’re seeing–30 year yields going nowhere, and short term rates at rock bottom. As you can see, the high yield is probably a result of the market saying “things can only get worse”. This isn’t exactly true, however, as Annaly is at a very low leverage level (about 6x). If long term interest rates rise and they like what they see, then they can leverage up and increase returns.
Disclosure: I don’t own NLY (or any other MREIT) but I want to. They keep going up and I haven’t picked a spot to buy in. I’m targeting close to the 200 DMA as a buy point.
(Back to Jubak.) If the MBSs are federally guaranteed, then why should there be any premium to Treasuries? And how is this even a half-step toward getting the taxpayers off the hook? Is there a cash flow (mortgage payments) to these securities? Too many unanswered questions.
The bullish activity in NLY over the last few months tells me private capital is starting to show interest in MBS’s again. Obviously, the big worry is that interest rates will shoot up, thus MBS values down. This may not be the entire case, however, as NLY is able to largely hedge against rising rates and purchases adjustable rate securities. There duration is something like a low 1.2 (a 100 bpts. raise in rates equals a 1.2% drop in asset value). So, the bullishness may be more of a bet on the curve staying wide rather than on long term rates staying moderate. Either way, yield needs to come from somewhere, and maybe we’ll see mean reversion as GSE guaranteed MBS’s are seen almost equivalent to US Treasuries.
Those interested in getting into this offering have another option. From what Jim wrote, it sounds to me like these are basically the same MBS’s that you buy from Fannie and Freddie. The only difference is where the guarantee comes from–1 from the Federal Reserve and the other from Fannie or Freddie, which are guaranteed by the US Treasury anyway. Both are guaranteed by taxpayers, so I don’t see a difference.
There are plenty of mutual funds that invest in MBS’s. All you have to do is take a trip over to morningstar.com.
Ditto STL. Hopefully, we’ll do well with it.
EdMcGon…
Enjoyed today! Secured 75 shares!
Thanks a bunch!
If you have a Vanguard account, you can get live updates on specific stock prices in their research screen (although in your portfolio screen there’s a 20 minute delay).
LOL…now, THAT’s a funny story and hard to believe!
Do you see the stocks in real time because you have some kind of software up and running?? E-trade has a 15 min. delay, so I’ve been watching MSN (20.68) and Etrade (20.71).,,
BRXX reminds me of a horse I saw once at a race. It threw the jockey when they were trying to get the horse in the starting gate, then ran the entire track in the opposite direction before they finally caught it.
The jockey got back on it, and they got the horse in the starting gate. That horse won the race by several lengths easily.
Some stocks get like that.
EdMcGon…
Gotcha…I was just going to write you about watching it go North rather than South this afternoon!
STL,
BRXX seems like it wants to run. You may have to raise your limit price to $20.75. If you can’t get it there, I’d buy it at market price right before the close.
I’d also like to know how an individual private investor gets in on these kinds of sales. Do you go through your normal broker, like TD Ameritrade, or do you go through TreasuryDirect? Or is it just not possible w/o a 6-7 figure investment?
Jim, would love to see more “mechanical” details like this covered. Damn banks are getting healthier, so savings/CD yields are completely in the toilet now; need to find some yield somewhere 🙂
Speaking of tax payers’ money, did you read that Citi group’s Pandit is planning to thank the taxpayer for the $45B. bailout! Is he a nut?! That’s like Madoff thank his investors for the money!
I’ll stay away from real estate indefinite time. I sold all my REIT in the last few weeks.
I won’t touch any things that are controlled by government or union infested companies either.
STL,
You’re silly. 🙂
It may not hit your limit price today. If not, then wait until tomorrow, or raise your limit to no more than $20.60 (although give it a few hours first).
Right now, the markets are down on Brazil. You should be able to get a good price.
EdMcGon…
Heyyyy, you taught me something today! This was my very first “limit” order I placed! Stuck in the $20.50 price for 75 shares…that’s a “pinkie” dip, don’t you think?!! Wait, can you call your baby toe, a pinkie???
STL,
LOL!
Remember, dip your toe. Don’t buy it all at once. If you’re going to buy it today, I’d set the buy limit price at $20.50.
Oops…BITE, not bit…duhhhh!
EdMcGon…
Okay, okay, okayyyyy…
I’m getting ready to bit the dust and buy some BRXX…wish me luck!! 🙂
STL,
I’d hold INTC at this price. I’d call it a “buy” at $19.
You know how I feel about MRVL. As Cramer would say, “SELL SELL SELL!”
EdMcGon…
Thanks, I forgot about it not being an individual stock! Forgive me!
If you owned INTC and MRVL…which one of the two would you cut loose first?? I’m sure you’re going to say both!! chuckling…
Run26.2,
I personally try to avoid REIT’s, since many of them are involved in commercial real estate.
I still haven’t decided how I feel about MBS’s.
STL,
Keep in mind that BRXX is an indexed ETF, not a stock (although you can buy and sell it like a stock). It’s price will float with the underlying index (which consists of 30 Brazilian infrastructure stocks), NOT what people bid/ask for the ETF itself.
BRF works the same way.
EdMc:
Here is the article on CIM:
http://seekingalpha.com/article/188070-chimera-s-swoon-offers-reit-investors-an-opportunity
EdMcGon:
Two stocks that I have been watching b/c of their huge DYs are CIM & NLY, both are REITs that focus on buying mortgages and are yielding 16-17%. I’m leery b/c the DY is so high (too good to be true?) and also trying to get a handle on their holdings (plus REITs can be a tax pain). I will try and find a link to an article that originally got me looking at CIM, but I thought it had better holdings. Of course please do your own DD.
EdMcGon…
Got a question for you! BRXX is brand spanking new and I’ve been watching it for 2 days now and am curious as to why it would be going down rather than up?? Seems silly to buy it and then turn around and sell. Why would that happen??
bob,
I am NOT talking about buying shares of Freddie or Fannie, for the very reasons you are stating. I’m talking about potentially buying the MBS’s.
I’ve got an answer for “should we?”. The way Fannie & Freddie are currently managed, NO WAY would I! Is this attempt to put lipstick on a pig? Perhaps they need to show investors they’re fixing internal problems (I’m not convinced they’ve done enough or anything for that matter) then make such an offering! Bad management + inticements (govt backed or not) does not necessarily = a good deal for tax payors or investors!
Jim,
Two questions:
1. How does the average private investor take advantage of this?
2. Should we?