Though one of the longest bull markets in the history of the mortgage bond sector is showing some signs of sputtering, the bonds remain a popular option for investors still wary of undulating stock markets and Enron-blemished corporate debt.
Riding on the back of last year's record mortgage loan volume, issuance of mortgage-backed securities doubled to more than $534 billion in the first quarter from the year-ago period. And because of the broader economic troubles over the same period, demand from investors swelled, market observers say.
"Mortgages have enjoyed a great run" over the last year, said Srinivas Modukuri, a mortgage strategist at Lehman Brothers.
According to the Bond Market Association, new MBS issuance was a record $1.67 trillion in 2001.
Mr. Modukuri said the mortgage-backed-securities sector benefited from stable rates, he said, which have hovered close to 7% for the last 12 months. And their performance has gotten a boost this year as banks and other corporate investors, desperate to find a secure place to park cash, have gobbled up mortgage-backed debt.
"In the current environment, mortgages have ended up as the only asset class that offers attractive nominal spreads," Mr. Modukuri said. All the untoward events in corporate America have money flowing into mortgages, since they are a relatively safer asset category, he said.
"Banks are having a very rough time trying to grow their loan portfolios, and as a result, they have had to turn to the securities market to put cash to work," Mr. Modukuri said.
Douglas Greenig, head of mortgage-backed trading at Greenwich Capital, agreed. "Liquidity is shaky everywhere, and investors wonder what the next credit event will be," he said. By contrast, he said, mortgages offer spread and superior liquidity. Mortgage bonds "are the spread product of choice in these uncertain times," he said.
Most observers said that, because of continued uncertainty over much of the economy, they expect mortgage-backed securities to keep doing well.
"The overall environment continues to be very favorable for mortgages," Mr. Greenig said. The current steep yield curve and rate stability enable investors to garner solid returns on mortgages "without rolling the credit risk dice," he said.
"Demand from banks, insurance companies, and money managers remains solid as buyers scoop up both passthroughs" and collateralized mortgage obligations, Mr. Greenig said.
Art Frank, head of mortgage research at Nomura Securities International, said players feel that the Fed will refrain from tightening over the next few months, and as a result the yield curve will remain steep. "For many months to come, we'll have a trading range for the market that is positive for mortgage bonds," he said.
Of course, most observers said the mortgage-backed market cannot stay this robust forever. The prevailing factors "are not sustainable indefinitely," Mr. Modukuri said.
Demand from some players has cooled, and some investors, including Freddie Mac, say that mortgages are too expensive. The cost caused Freddie to pull back from the market and report its first portfolio decline ever in April.
At some point the economy will recover, the Fed will raise rates, and concerns about corporate debt will diminish, Mr. Modukuri said. When that happens, investor demand will also fall, he said.
"The question of the day is how long will that take," Mr. Modukuri said. "Our call in this situation is that it will persist for at least six months and then gradually ease out."
Alexander Crawford, head of mortgage research at Deutsche Bank Securities, said the mortgage market has faced changes in investor behavior in just the past month. Money managers who had been adding mortgages to their portfolios early in the year have decided to take some profits, he said, and reduce their risk.
Many banks have also slowed their intake of mortgage bonds, Mr. Crawford said, though many high-profile banks continue to purchase and trade mortgages.
Investor interest in mortgage-backed should sharpen once the bonds become more affordable, but what happens next in the corporate debt sector will really dictate demand, Mr. Crawford said. "If corporate bonds start to recover from this Enron-induced malaise, then you will see investors piling into that sector and selling all of the safer securities they own, such as mortgages and Treasuries," he said.
Nonetheless, growing interest in Europe may keep demand for mortgage bonds strong, Mr. Crawford said.
"European investors are starting to get involved in U.S. mortgages for the first time" this year, he said. "The snowball is there and is rolling downhill."
