Mortgage Focus: Private Label MBS -- Who Owns This Stuff? by Nancy Vanden Houten

--Stone & McCarthy (Princeton)--It's harder to identify the owners of private label MBS using data sources like the flow of funds report than it is to track down owners of other assets. But we work with what we've got. If our analysis is at all close to the mark, foreign-based investors are one of the largest, if not the largest holder of private MBS.

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The Fed's quarterly flow of funds report contains a vast amount of information on the ownership of financial assets. The report gives us some data on the private-label MBS market, but not as much as detail as we would like, when it comes to who holds these securities. In this comment, we summarize the growth in the market on the supply side, and provide as much information as is available from the flow of funds report and other data sources on who holds private label MBS.

The Supply of Private Label MBS

The Fed's presentation of the private-label MBS market isn't exactly straightforward. The flow of funds report doesn't include a line item for private-label MBS. Instead, it identifies the assets of private-label issuers that back their MBS. Single-family mortgages account for more than two-thirds of those assets, but private issuers also securitize multi-family mortgages, commercial mortgages and agency/GSE MBS. In total, securitized assets on the balance sheet of private issuers -- our proxy for their outstanding MBS -- increased by about $400 billion to $2.655 trillion in 2006. Since 2001, the supply of private-label MBS has nearly tripled.

Again, on the liability side the Fed doesn't specify MBS, but rather breaks down ABS issuer liabilities into commercial paper and corporate bonds. For the rest of our analysis we will assume that all MBS issues fall into the corporate bond category. At one point in time, other assets such as consumer credit loans and trade receivables backed a significant share of private-label ABS. More recently, those shares have been dwarfed by the growth in private-label securities backed by mortgage assets.

See table that follows. Who are the owners of these securities? That's more difficult to decipher using the flow of funds data. For some investors, such as commercial banks, the Fed specifically identifies holdings of privately issued mortgage-backed securities. For some investors, such as foreign investors, any holdings of private-label MBS are combined with holdings of corporate bonds. Holdings of hedge funds would be buried in the corporate bond holdings of the household sector if the hedge fund is U.S. based, and in the holdings of foreign investors if the hedge fund is located off-shore. And it's virtually impossible to estimate investments of CDOs (collateralized debt obligations) in private-label MBS, based on the flow of funds data.

CDOs represent another level of securitization, and increasingly are packaging MBS in their structures. (We liked a recent comment made to Bloomberg by PIMCO's Scott Simon that CDOs, not "real people" bought subprime loans last year.) We have seen estimates of CDO purchases of private-label MBS in 2006 ranging from $150 billion to $175 billion, but we don't know of any public source that clearly identifies the involvement of CDOs in the markets. According to the Fed, CDOs should technically be reflected as liabilities of asset-backed issuers. However, to the extent CDOs are created out of other asset-backed securities -- or other CDOs for that matter -- they would not be specifically reflected. The bottom line seems to be that at best holders of private-label MBS via a CDO would be identified as a holder of a private-label MBS in the flow of funds data.

Below we summarize holdings of private label MBS by investor group, in order of how much detail we have, starting with investors for which the Fed itemizes private- label MBS holdings.

Before we begin our review of investor holdings, a couple of comments about the subprime share of private-label MBS are in order. The Fed data don't provide a breakdown between subprime and other MBS. Available data show that the subprime shares of mortgage originations and securitizations have grown dramatically, but still account for less than a quarter of the private-label MBS market. The following table summarizes data through 2005; we have seen estimates for 2006 that suggest the pace of subprime originations in 2006 was about the same or slightly lower than in 2005, but that the market share may have increased slightly. While it would be ideal to have a breakdown between investors' prime and subprime holdings, we also think it's important not to think in terms of a "bright line" distinguishing subprime loans from other mortgages. As we noted in a recent comment, the distinctions between prime and subprime loans are increasingly blurry, and we think there is cause for concern that problems will develop outside the subprime market, including in the the Alt-A market. (See Mortgage Focus: If You're Trying to Keep Track, 3/6/07.)

Now back to our review of investor holdings of private-label MBS.

Commercial Banks

Commercial bank holdings of private-label MBS were $191.6 billion at the end of last year, up from $170.1 billion in 2005 and up from $84.6 billion at the end of 2001. Most of commercial bank holdings of private-label MBS take the form of CMOs and other structured products.

Savings Institutions Holdings of private-label MBS by savings institutions were $76.1 billion at the end of 2006, up from $66.2 billion in 2005, and up from $13.2 billion at the end of 2001. The growth in thrift holdings of private-label MBS has been in holdings of CMOs and structured products. All of that growth has occurred since 2003; savings institutions held none of those securities prior to 2004.

The FDIC publishes securities holdings for individual institutions when quarterly call report data are released. The following table shows the top 10 bank/thrift holders of private-label MBS as of the fourth quarter. ING bank had the largest holdings, with $32.4 billion.

The GSEs

The GSEs' holdings of private-label MBS increased to $406.0 billion in 2006 from $384.6 billion in 2005. GSEs' holdings of private-label MBS at the end of 2006 compare to $155.7 billion in 2001; private-label MBS accounted for 30.7% of their total MBS holdings, up from 13.3% at the end of 2001. To be accurate, the Fed's flow of funds report doesn't identify GSE holdings of private-label MBS, but reports their holdings of "corporate and foreign bonds." However, the GSEs' own reports of their holdings of private-label appear to explain virtually all of GSE holdings of corporate bonds. At the end of 2006, Freddie Mac reported holding $238.1 billion in non-agency MBS, and Fannie Mae reported holding $114.5 billion. We don't have a figure yet for Home Loan, although Home Loan had holdings of about $75 billion at the end of 2005. Unfortunately, it is more difficult to estimate holdings for other investor groups since, as we mentioned above, they are part of overall holdings of corporate bonds. One group where we may have some more insight thanks to the Treasury's TIC data is foreign-based investors.

In the flow of funds report, the Fed reported foreign holdings of corporate bonds of $2.738 trillion as of the end of 2006, or just over 29% of outstanding U.S.-issued corporate bonds.

How much of foreign corporate bond holdings might be comprised of private-label MBS?

We can start with the Treasury's benchmark portfolio survey of foreign holdings of U.S. securities. Unfortunately, this data is released with a lag of almost a year, so the latest figures we have are for June of 2005. As of June 2005, Treasury reported foreign holdings of $1.729 trillion in corporate bonds, with ABS accounting for $452.7 billion or 26.2% of the total.

We think foreign ABS holdings as of June 2005 will be revised sharply higher, however. First, the flow of funds report shows a sizable upward revision to foreign corporate bond holdings as of that benchmark date. When the first release for that period came out in September of 2005, the flow of funds report showed foreign holdings of $1.898 trillion. (We aren't exactly sure what might account for the difference between flow of funds and the TIC data.) In subsequent quarters, however, foreign holdings of corporate bonds as of June 2005 have been revised higher; in the most recent report, they were estimated at $2.203 trillion, an increase of more than $300 billion relative to the first estimate.

Probably more significantly, last summer Treasury revised sharply higher its estimates of prepayments on corporate ABS to foreign investors. In doing so, Treasury said that foreign holdings of asset-backed securities had increased more than expected, and that its estimate of the mortgage share of corporate ABS had been revised higher. (For a further discussion, see Mortgage Focus: More Private Label MBS in Foreign Hands, 8/18/06.)

In trying to estimate foreign holdings of corporate ABS, we looked specifically at the revision to prepayments for June of 2005, the benchmark survey month. Treasury revised those prepayments up to $7.082 billion from its last estimate of $3.779 billion. Assuming that the prepayment rate assumption didn't change, that would imply foreign corporate ABS holdings of about $848 billion, or about 38% of all foreign holdings of corporate bonds, if we use the latest flow of funds estimate for the second quarter of 2005 as our denominator.

If we further assume that ABS continue to account for 38% of foreign holdings of corporate bonds -- which might be conservative -- using the fourth quarter figure of $2.738 trillion would imply ABS holdings of $1.040 trillion. Presumably some of those holdings are not securities backed by mortgage-related assets, but we think that share is probably somewhat small given how the majority of corporate bonds issued by ABS issuers have come to be backed by mortgage assets. Even if our estimate is high, we think based on revisions to the flow of funds report and the prepay data, it's not unreasonable to assume that foreign holdings of private-label MBS total somewhere between $800 billion and $1.0 trillion.

If our estimate is at all close to the mark, it implies that foreign-based investors could conceivably be the largest holders of private-label MBS. We think it's important to reiterate that this figure would include the holdings of any U.S. hedge funds that may be legally based off-shore.

Again, if our estimate for foreign investors is realistic, it implies that foreign investors, banks, thrifts and the GSEs collectively hold more than 60% of private label MBS. Unfortunately, this is where we run into a brick wall with our analysis, since we don't have a sense of how to estimate what share of foreign bonds held by other investor groups would be comprised of private-label MBS.

We looked at the other major holders of corporate bonds; the table below summarizes the holdings of the top five investor groups apart from those we've already discussed. Life insurance companies were by far the largest, with holdings of corporate bonds of $1.882 trillion. Our understanding is that life insurance companies are traditionally buyers of MBS, but we just don't have a basis for estimating their allocation to MBS versus other types of corporate bonds.

One other observation is in order with regard to other major holders of corporate bonds. The household category in the federal funds data is a residual one that captures holdings that can't be allocated elsewhere. That would include hedge funds based in the U.S.

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© Stone & McCarthy Research Associates Inc., 2007