As refinancings of home loans surge, banks are turning decidedly cautious on investing in mortgage-backed securities.
The industry is starting to pull back from the instruments after boosting its holdings by nearly 10% in the 12 months through Sept. 30, to $270 billion, an American Banker survey shows. (For rankings of the top 50 banks in the field, see page 10.)
"We're cautious on mortgages going forward," said Michael Buttner, senior vice president and portfolio manager for First Union Corp. "We would only add mortgages if we felt we were getting paid for the prepayment risk that we're taking."
Homeowners across the country have begun paying off their mortgages early in order to take out new ones at lower rates. As loans backing securities are prepaid, investors can lose both principal and interest income. The dangers are especially high for certain classes of collateralized mortgage obligations.
Mortgage securities are a natural investment vehicle for banks, which as mortgage lenders can hedge the risks of the securities without turning to complex and expensive hedging strategies, said Stephen Smart-O'Connor, managing analyst of mortgage data at Technical Data.
Mr. Buttner said, however, that First Union would only use mortgage- backeds "when we feel they are priced appropriately for the environment that we are in."
The Charlotte banking company had the fourth-largest portfolio of mortgage backed securities in the nation, with more than $13 billion, a 12% increase over Sept. 30, 1996, according to the American Banker survey.
In the final quarter and first weeks of January, banks have grown more conservative, and have tried to reduce their exposure to securities backed by higher-rate loans-the ones that are most likely to be refinanced.
"We've been trying to protect ourselves by moving out of premium coupons that we own and moving down in coupon into lower coupons," Mr. Buttner of First Union said.
First Union is also concerned about mortgage extension risk as investors maneuver to purchase lower-rate mortgages and the bank is using caps, which provide income as rates rise, to protect themselves, he added.
Another southeastern bank, SunTrust Banks Inc., purchased adjustable rate Ginnie Maes and some floating rate CMOs throughout 1997, said Donald T. Heroman, senior vice president and treasurer.
SunTrust's production and origination of loans helps to hedge the prepayment risks associated with refinancing, he said.
"Since we're a pretty big originator of first mortgages through our retail system, while we'll lose the asset, we'll generate fee income because of the mortgage origination capability we have," Mr. Heroman said.
Chase Manhattan Corp., New York topped the list for mortgage security investments with over $26 billion in its portfolio, up 3% from 1996.
Among the fastest growing MBS investors were BankAmerica Corp., whose MBS investments rose 46% to $21.3 billion; NationsBank, up 32% to $21.3 billion; and J.P. Morgan & Co.'s up nearly 25% to 15.3 billion.
Including loans in portfolio, the industry's investment in mortgages was approaching the trillion-dollar mark, at $998.15 billion, up 8.38% from 12 months earlier.
First USA Bank, Wilmington, Del., now a division of Banc One Corp., had the highest percentage of its securities portfolio in mortgage-backeds- nearly 99%.
The survey also indicated that growth in collateralized mortgage obligations, which are generally more vulnerable to rate risk than pass- through securities, was relatively modest. CMO investment was up 1.75% for the industry, to $116.5 billion.