WASHINGTON, DC—Investor demand for mortgage bonds, both that have agency backing and not, is quite high these days.

Last week Bloomberg reported that issuance of home-loan securities that don't have government backing reached more than $32 billion this year, compared to $18 billion a year ago, citing data compiled by Bloomberg and Bank of America Corp. These securities include rental-home bonds, a relatively new asset class that developed after the recession.

Agency and GSE securities are also in high demand, as a recent report from the Mortgage Bankers Association indicates. The level of commercial/multifamily mortgage debt outstanding increased by $40.4 billion in the first quarter of 2015 -- a 1.5% increase over the fourth quarter of 2014. Said Jamie Woodwell, MBA's Vice President of Commercial Real Estate Research with the report's release: "Multifamily mortgages continued to grow even more quickly than the market as a whole, with banks increasing their portfolios by $8 billion and agency and GSE portfolios and MBS increasing their holdings by $10 billion."

There are a number of economic-based drivers behind the demand for mortgage bonds of course: the fundamentals in the real estate space and the low interest rates that have driven investors to consider all manner of securities to eek out yield.

However, there is another possibility to consider as well and that is that the changing financial regulations are driving both issuance and investment.

On one hand, mortgages and private-label mortgage backed securities are much more regulated per Dodd-Frank and its Qualified Mortgage and Qualified Residential Mortgage rules, according to David Reiss, professor of Law and research director of the Center for Urban Business Entrepreneurship (CUBE) at Brooklyn Law School. On the other, post-crisis rules put in place for mortgage bonds have made these securities far more attractive for banks to hold as various news reports suggest.

For example, new rules have made ratings on mortgage bonds less crucial, allowing US lenders to use an alternative approach to calculating capital requirements, according to another recent article in Bloomberg. In essence, these rules allow lenders to reduce the amount needed for junk-rated mortgage bonds that are trading at discounts.

In addition, banks are finding that "treasury debt and MBS pass-throughs meet regulators' standards much more easily than other assets", according to a report by Deutsch Bank analysts Steven Abrahams and Christopher Helwig, per a third recent article in Bloomberg.

Two Opinions

With these facts in mind we turned to two experts to see how much of an impact new regulations are having. As it turned out, they are driving some of the change – but what is actually moving the needle in terms of demand is yet another trend. Read on.

For starters, there are some caveats. It can be misleading to throw the new rental home bonds in the mix in such a comparison, Reiss tells GlobeSt.com. "They are a post-crisis product when Wall Street firms saw that single-family housing prices were so low that they could make money from buying them up in bulk and then renting them out," he says.

"They are not regulated in the same way as private-label MBS."

Meanwhile issuers are still navigating Dodd-Frank's Qualified Mortgage and Qualified Residential Mortgage rules, he says. They "are still trying to figure out how to operate within these rules -- and outside of them, with the origination of non-QM mortgages. The market is still in transition with these products."

As he sees it, the surge in issuance is a reflection of market players trying to understand how to operate in a new regulatory environment. They "are increasing their issuances as they get a better sense of how to do so."

Another take on this question comes from Sreeni Prabhu, chief investment officer of the Atlanta-based Angel Oak Capital Advisors. He does agree that rating on mortgage bonds have become less crucial since the financial crisis as a result in regulation. He just doesn't think this change is the reason behind the increased issuance. I will let him explain:

"In the pre-crisis days, banks had a ratings-based approach to investing in these securities within their portfolios. They were required to have a minimum rating and were relying on the rating agencies for those grades.

"When the financial crisis hit, banks realized that this approach needed to be reformed, since rating agencies were shown to be imperfect. In 2013, a new system called the Simplified Supervisory Formula Approach (SSFA) was developed to calculate risk weighting for asset-backed securities. It determines how much capital a bank much reserve for a given security and has reduced the dependence upon ratings and the agencies that issue them.

New Thinking By Investors

But that procedure change is not the reason behind the increased issuance, he continues. "Rather, there are other factors facilitating the increase," he tells GlobeSt.com, including new thinking on the part of investors.

In the pre-crisis era, banks were the primary investors in non-agency mortgage-backed securities, Prabhu says. After the crisis, investors concluded that mortgage credit is an asset class that should be in every fixed income portfolio. "It's this expanded buyer base that has created additional demand for mortgage products and spurred recent volume," he concludes.

The market is also experiencing an interesting shift in demand-supply that in part has led to the surge in issuance, he says. Take it away Prabhu:

"The new issue market has been anemic over the last few years, as people are trying to wrap their heads around new regulation and risk retention rules. Investors are slowly getting back into the space. For a long time legacy mortgage securities were very cheap, but the sun is setting on those opportunities as they continue to amortize and supply shrinks. Buy and hold investors have taken them out of the market. It's that reduction in supply that has incentivized investors to look elsewhere for mortgage credit and therefore led to an increase in new issuances."

Next-generation Mortgage Market

Consider this all the unfolding of the second generation of today's mortgage market, he said. "The capital being raised appears to be long-term capital, as investors are realizing that mortgage credit is an important part of today's fixed income portfolios. The new issue non-agency market will continue to evolve and non-QM issuances will likely start to pick up as well."

The new regulations do have an important role, though, in this mix, he says. Under the new risk retention regulations issuers will be required to retain a portion of each deal issued. "This should lead to more responsible credit underwriting, as issuers will be operating under an 'originate-to-hold' model instead of the pre-crisis 'originate-to-sell' model." t

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What Else Is Behind Rising Mortgage Bond Issuance, Demand?

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