Mortgage Securities Are a Good Investment if Loan Demand Is Low
TALLAHASSEE, Fla. -- Despite all the bad press mortgage-backed securities have received--or actually, because of it--some credit unions are snapping up the controversial investments, which many think are presently undervalued.
Dan McGowan, senior vice president/chief financial officer of $208 million Envision Credit Union, recently invested $33 million in mortgage-backed securities, representing his credit union's entire investment portfolio.
Though he would have preferred to loan the money to members, McGowan said Envision is currently experiencing low loan demand and has experienced an influx of deposits from members who have soured on banks and Wall Street. Those market conditions, coupled with the maturity of some laddered CDs, prompted the CFO to shop around.
"The market is dysfunctional right now, and pricing on mortgage-backed securities doesn't really reflect their ultimate value," McGowan said. "So we started thinking, hey, while this dysfunction exists, we have an opportunity to look at specific securities and see if we can cherry pick."
Southwest Corporate helped McGowan find what he was looking for: agency-backed securities that spin off principle and interest, providing a revenue stream, with a weighted average of 24 to 36 months.
"We'll have large quantities of cash coming back in right around the time we anticipate loan demand will pick up," he said, "which works well with our ALM strategy."
Brian Turner, director of advisory services at Southwest Corporate, said mortgage-backed securities are a good deal these days, but his phone isn't ringing off the hook as a result. While there are a few credit unions in Envision's bind, most are experiencing the opposite: strong loan demand with few deposits. And, with spreads improved over recent years, those with excess deposits can earn a better return lending to members.
"Those who have liquidity and don't have demand on the loan side are being very proactive in investments, and mortgage-backed securities are giving the best relative value," Turner said. "They should be agency-backed with durations from one to three-and-a-half years with good cash flow structures built in."
Structure is key to successful MBS investing, Turner said, because a drop in mortgage rates could usher in a new era of refinancing, abruptly ending a security's revenue stream. The credit union's securities are GSE-issued and AAA-rated, so they are typically backed by traditional, 30-year fixed mortgages held by prime borrowers.
Depending on what numbers you use, Turner said, current market rates are already 25 to 50 basis points below average mortgage coupons, so a drop in rates could trigger refinance activity.
"Of course, the question is whether or not anyone is in a position to refinance," Turner said.