More and more banks are selling high-stakes financial products that give investors exposure to America’s mortgages, auto loans, and corporate bonds.
The new bond product offers investors high returns – including some over 5 percent – but hooks those same investors if underlying credit goes down, like that a report by doing Wall Street Journal.
The newspaper reports that Texas Capital Bank sold $ 275 million of these risk-transfer securities earlier this year. The regional bank has added its name to a list of larger institutions that sell similar bonds, including Citigroup and JPMorgan Chase.
“The inclusion of Texas Capital Bank on the list in March this year shows that this mechanism can still grow,” said Simon Boughey, an analyst at Structured Credit Investor, the diary.
For banks, these products represent an opportunity to expand their balance sheets and ultimately lend more money. For investors, they offer higher returns than other bond products – but also the obligation to cover losses if borrowers default on their loans.
If this practice sounds familiar, it’s because it resembles some of the financial practices that became popular with investors in the mid-2000s as the U.S. housing market headed towards mass foreclosure.
Industry experts say the housing market stay healthier today than in the run-up to the subprime mortgage crisis. Not only are today’s borrowers better qualified to take on debt, but their mortgages are more likely to have fixed interest rates that ensure a more predictable monthly payment.
Meanwhile, the record price increases seem unique Supply and demand factors that get stronger during the pandemic. These conditions maybe starting to improve from the buyer’s point of view, but remain far from a return to normalcy.
These types of securities were originally created to protect Fannie Mae and Freddie Mac from some of the mortgage market risks, the newspaper reported. Now they are becoming increasingly popular with institutional investors.
The returns on these new bond products can be over twice that of US Treasuries and more traditional mortgage-backed securities, the report said.
Their rising popularity also coincides with falling interest rates and falling returns on similar products.
“People want exposure to the real estate and consumer markets that are developing,” Kaustub Samant, JPMorgan’s securities analyst, told the newspaper. “Risk transfer papers are one of the few places that generate high returns in this environment.”
Yet these products remain a very small part of the market, investors told the diary. Time will tell whether they will stay that way.
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