By Jody Shenn

July 1 (Bloomberg) — Banks are buying the mortgage-backed bonds that hobbled the global financial system, helping to sustain higher prices for the debt, according to Federal Reserve data, investors and traders.

Large U.S. commercial banks held $154.6 billion in mortgage securities that lack government backing on June 17, an increase of 5.6 percent since April, Fed data show. Typical prices for the most-senior such securities backed by prime-jumbo mortgages have risen to 75 cents on the dollar from 63 cents in March, according to Barclays Capital.

Banks are investing more in securities as deposits rise faster than lending. Commercial bank deposits have soared 9.5 percent to $7.56 trillion since the week before Lehman Brothers Holdings Inc.’s September collapse triggered a stock-market sell-off and about a month before the Federal Deposit Insurance Corp. increased coverage to $250,000 per account, from $100,000. Bank lending rose 1.4 percent to $7.01 trillion in the same period, Fed data show.

Some of the bonds “are selling at deep discounts” that “can represent great value,” said Robert Clarke, a former U.S. Comptroller of the Currency who is a senior partner in Houston at the law firm Bracewell & Giuliani LLP. “I just hope it doesn’t turn into a lemming-like response again” and “that banks, having been burned once by touching the stove, would not be buying this stuff unless they did a lot more due diligence than the people who bought it the first time around.”

Voluntary Reporting

Fed data on the securities, released each Friday, reflect voluntary reporting from about 30 unidentified banks with more than $40 billion in assets each, or about two-thirds of the total for all U.S. banks, the central bank says.

Spokespeople for JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co., Goldman Sachs Group, Morgan Stanley, M&T Bank Corp., SunTrust Inc., declined to comment on mortgage-bond investments or didn’t return messages.

“Nobody wants to admit they’re actually buying these things,” said Harry Davis, banking professor at Appalachian State University in Boone, North Carolina.

Mortgage bonds fueled the real-estate boom through 2006, especially those that lacked backing from government sponsored mortgage-finance companies Fannie Mae and Freddie Mac or federal agency Ginnie Mae. They dealt mainly in loans that adhered to tougher underwriting guidelines.

Starting in mid-2007, the most-senior classes of so-called non-agency securities began plunging with property values, helping spark more than $1.47 trillion in writedowns and losses at the world’s largest financial companies and contributing to a global recession, according to data compiled by Bloomberg.

‘Biggest Run-Up’

Before the bust, the bonds typically traded at about 100 cents on the dollar. By March 19, prices for the most-senior securities backed by prime-jumbo mortgages had fallen to 63 cents, according to Barclays Capital, a unit of Barclays Plc in London. Bonds tied to riskier Alt-A loans with at least two years of fixed rates touched 35 cents.

Since then, bonds tied to the jumbo loans have risen to about 75 cents and the Alt-A securities jumping to 47 cents.

“It’s probably been the biggest run-up of my career,” said Sean Kirk, a trader at the New York securities firm Seaport Group LLC who has been in the business since 1990. Banks of all sizes bought more of the debt last quarter, he said.

The securities are a focus of Treasury Secretary Timothy Geithner’s plan to have the government and private investors buy $1 trillion in devalued assets, freeing banks to revive lending. The March 23 unveiling of the Public-Private Investment Program, which has yet to be initiated, helped sparked the rally in home- loan bonds in the year’s first half.

Assessing Risk

Regulators are monitoring investments by banks on concern that some may not be equipped to assess their risk, Jim Embersit, the Fed’s deputy associate director for market and liquidity risk, said in a telephone interview.

In some cases, “examiners are taking action, such as requiring risk-management improvements, which can be substantial, and ensuring that boards of directors are aware of the risks,” Embersit said, adding that some of the bonds may be good investments.

Delinquency rates in the non-agency market continue to set records. In May, borrowers were at least 60 days late on loans that accounted for 23 percent of the non-agency market, up from 14 percent a year earlier, Bloomberg data show. About $1.8 trillion of the debt existed on March 31, Fed data show.

Banks are following the lead of hedge funds like Paulson & Co., which is investing in the bonds after making more than $3 billion on bets that housing would collapse. Paulson is “going long the better-quality jumbo, prime securitizations,” said Sandra Lee, a senior vice president at the New York-based funds, at a Euromoney conference in Hong Kong last month.

‘Isn’t Toxic’

“The stuff they’re buying isn’t toxic: It’s been mostly high-quality stuff at better levels than anyone could have possibly imagined,” said Scott Simon, head of mortgage-bond investing for Newport Beach, California-based Pacific Investment Management Co., manager of the world’s largest bond fund. “That doesn’t seem irresponsible to me.”

Banks are most interested in bonds backed by 15-year prime- jumbo loans from 2005 or earlier, or those tied to borrowers who didn’t buy homes at the top of the market or seek low initial payments, said George Boyan, head of mortgage-bond trading in New York at Source Capital Group.

“Banks are buying seasoned, high quality private-label MBS,” he said in a telephone interview.

At current prices, typical senior fixed-rate Alt-A securities likely will yield 11 percent, with 5 percent to 6 percent yields still possible in “Armageddon scenarios,” Seaport’s Kirk said.
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