LONDON (Reuters) – Global banks earned $1 billion from trading government-backed U.S. mortgage securities in the first half of 2019, data shows, a fivefold increase on last year for what industry sources say is the fastest growing revenue source in investment banking.
The shift this year to a more dovish interest rate policy by the U.S. Federal Reserve has sparked a surge in investor demand for packaged-up home loans issued by mortgage agencies Fannie Mae, Ginnie Mae and Freddie Mac.
Banks that trade these securities, known as agency residential mortgage-backed securities (RMBS), have profited both from increased commissions on trading them as well as holding them on their books as they appreciated in value.
The boom in trading comes just over a decade after the global financial crisis, caused in part by the collapse in value of much riskier bonds linked to U.S. home loans that banks packaged up and sold to unwitting investors.
Agency RMBS are considered far safer and higher quality than the subprime pools that sowed the seeds of the so-called subprime mortgage crisis in 2007.
The data from research house Coalition shows global banks made just $200 million in revenues in agency RMBS in the first half of 2018, compared with $1 billion this year.
“This is the fastest growing product across markets this year, for sure,” one industry source told Reuters.
“This is probably the first year that the RMBS guys are looking at some big bonus figures. I think it’s going to be good year,” the source said.
JP Morgan (JPM.N), Citi (C.N), Goldman Sachs (GS.N) and Morgan Stanley (MS.N) are seen among the biggest winners, with Bank of America (BAC.N) and Credit Suisse (CSGN.S) also cashing in, the source added.
Average daily trading volumes in agency RMBS have risen to $251 billion in 2019 so far, data from SIFMA shows, an 11% increase on the same period a year ago.
The earnings boost for the Wall Street giants that dominate this business is likely to widen the gap with struggling European rivals, which have seen profits plunge in recent years amid constant restructuring and sluggish domestic trading markets.
JP Morgan is likely to make as much as $500 million from agency RMBS trading in 2019, after ramping up the balance sheet capacity it allocates to the market to between $20 billion and $30 billion, the source said.
JPMorgan declined to comment.
The U.S. lender saw a 31% increase in its holdings of all securities between June 2018 and June 2019, according to a Reuters calculation from regulatory filings, driven by a 37% increase in ‘available for sale’ products such as agency RMBS.
Rate cuts typically drive demand in agency RMBS because they can change the time frames in which people repay or refinance the underlying mortgages.
This in turn changes the value of the securities, which yield-hungry investors seek to profit from.
The window of opportunity for banks to make money in agency RMBS trading is small and is not entirely without risk.
If the Fed suddenly changes its policy, as it did in 2013 here when a shift in its practice of buying bonds triggered a massive spike in U.S. Treasury yields, banks could be saddled with a hefty inventory of bonds which could plunge in value.
The Fed cut interest rates in July and at its subsequent September meeting to offset the impact to the U.S. economy from slowing global growth and the Trump administration’s trade war with China, which has hurt U.S. manufacturing and cooled business investment.
The next meeting of the Fed’s interest rate policy committee is on Oct. 29-30.
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