Banks forced away from loans and into low RWA assets in 2024

An unintended consequence of the implementation of Basel III endgame rules in the US is that banks will be forced into more capital efficient agency MBS at the expense of loans, according to Mohib Karzai, head of agency MBS trading at JP Morgan.

Karzai was speaking at last week’s panel to discuss the 2024 outlook for securitized products. He appeared alongside the head of CMBS and CRE loan trading, the head of RMBS trading and the co-head of ABS trading.

Under the punitive new regulations, banks have no alternative but to shift the asset mix. It is striking, noted Karzai, that the GSIBs, which currently labour under the most restrictive capital rules, are already heavily invested in securities not loans. Smaller banks which hitherto have enjoyed more latitude will find themselves in the same boat.

“The US$100bn-US$700bn banks have to adjust new capital regime. They can have a 50% RWA resi loan or a 100% RWA CRE loan or a 0% RWA Ginnie pass thru. When you’re forced to hold more capital banks will be forced to optimize their assets, and they’ll be pressured to move into securities,” he said.

He added that with the advent of portfolio method layer hedging the duration risk can be hedged away, allowing banks to be “duration agnostic.”

Portfolio method layer hedging is a fair value hedging procedure that can be applied to a closed portfolio of assets not expected to be repaid during the hedge period, and was expanded by the Financial Accounting Standards Board (FASB) in March 2022.

The absence of bank investors from many areas of the securitized products arena was a leading topic of discussion by all panel members last week.

Bank buyers are down to 5%-10% of the RMBS market from around 30% a few years ago, noted Marc Simpson, head of RMBS trading. For the most part, this deficit has been made up by insurance companies.

Private credit will make up for the deficiency on the lending side, it is hoped. This, as Lily McGettigan, co-head of ABS trading, is the “biggest buzz word’ in the market.

“Regulation is top of the agenda in 2024. This is going to make it very difficult for banks to lend. We could see a lot more private label securitizations as a result,” said Simpson.

A dark cloud has fallen across much of the CRE and CMBS market over the last year, concurred Jeremy Hellinger, head of secondary CMBS/CRE loan trading, but the wider spreads have created interesting trading opportunities. Levels are still very cheap to corporates, and AAAs could narrow by a further 25bp or more to get back to a more normal differential to other asset classes.

However, further cracks could open up in 2024, particularly in multi-family and low cap products, he suggested. With rates still much higher than they were a couple of years ago, borrowers have a negative cost of carry and refinancing will prove challenging for many.

Simon Boughey