Banks Return to Collateralized Derivatives Market

Banks Return to Collateralized Derivatives Market

Banks are using the low interest environment to once again snatch up mortgage related products that many believe helped cause the financial meltdown of 2008.  They are also starting to securitize the mortgages just as they once did.  This is the act of taking a mortgage and turning it into a security that you can trade over an open market, known as CMOs (collateralized mortgage obligations).  The banks are yet again using mortgage securities because they tend to yield higher than US Treasuries and most dividend stocks.

Last week, the Federal Reserve said they will be keeping interest rates low till at least 2014, making this balance-sheet management easy for the banks as it is hard for them to turn a profit off investments and loans when rates are high.  Banks increased their CMO exposure by $82 billion in the first nine months of last year to a total of $479 billion worth of CMOs.  As we have seen, CMO exposure has gone up in the last year, while US Treasury exposure was cut.

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The difference between the mortgage securities of 2008 and the current securities being bought is that the current mortgages are backed by the US government; thereby making it a very attractive and “safe” investment.  Since the US government is backing these securities the only real risk is the interest rate increase but, as signaled by the Federal Reserve, will not occur to at least 2014.

This is a big money making opportunity for the banks.  Their mortgages are pretty much as safe as Treasuries, yet they will yield much more and give banks a profit boost.  Although banks have been lagging the market, I believe the opportunity to get in for a long term investment is right around the corner.  Banks are beginning to become profitable again and they will continue to churn out a profit with these mortgages in their toolbox.  Watch banks closely for more signs of profitability.