Hunting for higher yields in a low-rate environment, banks plan to increase investment in mortgage-backed securities this year, a survey of 25 of the largest banks found.
The survey, conducted by Lehman Brothers, also found that the prospect of market-value accounting and an increase in loan demand were changing bank investment patterns.
Shorter Maturities Chosen
Bankers are opting for adjustable-or fixed-rate mortgage securities with maturities of five years or less. More than three-quarters of the banks said they were gradually shifting to securities less sensitive to changes in interest rates.
"Regulation changes and an expectation that loan demand may soon increase have substantially shifted bank investment strategies toward shorter duration securities," said Evy Adamidou, vice president and portfolio strategist at Lehman Brothers.
By planning to shorten the maturities of their investments, banks are responding in part to the Securities and Exchanges Commission's moves, on its own or through the Financial Accounting Standards Board, to institute mark-to-market accounting for investment securities, according to the survey.
Prices of short-term securities are less volatile than long-term fixed-rate investments.
Top Banks in Survey
The report also separately analyzed securities trading at half of the 100 largest U.S. banks. It found that one out of six banks traded 80% or more of their in-portfolios in 1991. Just 6% of the banks turned over their portfolios this aggressively in 1990.
For much of this year and all of last year, weak loan demand caused banks to invest heavily in medium-term U.S. government securities. But wide yield spreads between mortgage securities and Treasuries have led to a rethinking of strategies.
The yield on a five-year collateralized mortgage obligation is about one percentage point higher than that of a Treasury security of the same maturity.
About 60% of the 25 banks surveyed said they planned to increase holdings of mortgage-backed securities holdings this year, while one-third said they may raise Treasury investments.
To be sure, increased investment in mortgage securities brings prepayment risk. Mortgage refinancings, usually heavy when interest declines, cause issuers to pay the principal on mortgage securities ahead of schedule. This means an investor may have to reinvest the principal at a lower interest rate.
In the second quarter, for instance, Norwest Corp.'s net interest margin declined by 4 basis points to 5.36%, partly because of prepayments on mortgage-backed securities.
Bank appetite for all types of securities will remain strong in the second half. About 65% plan to increase securities investments this year, while 30% expect holdings to remain stable.
In addition, banks with healthy risk-based capital ratios said they would take on more credit risk by raising investments in nonagency mortgage-backed securities. These bonds do not have repayment guarantees from triple-A-rated U.S. government agencies such as the Federal National Mortgage Association.