The US government has been looking at ways to offload nearly $13 billion of mortgage bonds it amassed from failed lenders Silicon Valley Bank and Signature Bank, according to people with knowledge of the transactions.
The bonds are backed by long-term, low-rate loans made mainly to developers building affordable apartment buildings. They were part of a $114 billion portfolio that ended up with the Federal Deposit Insurance Corp. when it took over SVB and Signature.
The FDIC hired BlackRock to help liquidate the broader portfolio, and the money manager sold most of the assets within a few months. But BlackRock didn’t offload what has turned out to be the trickiest holding: about $12.7 billion of bonds tied to project loans supported by Ginnie Mae. The FDIC has discussed alternatives to slashing the prices on the bonds, including potentially repackaging the debt into new securities, the people with knowledge said.
BlackRock had preliminary conversations with investors about the bonds, according to the people, who asked not to be identified discussing non-public information. But the securities proved hard to sell in part because the bonds will probably pay below-market coupons for years. The loans backing them were made before the Federal Reserve started hiking, often come with high penalties if they are refinanced in their first 10 years, and can take decades to mature.
The project-loan bonds the FDIC aims to offload amount to the volume that Ginnie Mae often sells in about a year. The trouble with these bonds underscores the pain that failed banks can bring to the government, even after new lenders take them over.
“It’s a very large chunk of bonds, and there are so many factors here working against the easy liquidation of these assets,” said Richard Estabrook, a mortgage backed securities strategist at Oppenheimer & Co, who isn’t directly involved in the sale but has looked at the bonds. “By comparison, everything else was straightforward.”
BlackRock declined to comment. The FDIC confirmed the bonds were not part of the BlackRock sales process and declined further comment.
The FDIC has looked at restructuring the Ginnie Mae debt into more complicated instruments, according to a person with knowledge of the matter, who was not authorized to speak publicly about it. But even if such a move allowed the government to offload some of its risk, the FDIC would probably still be left holding hard-to-sell longer-term securities.
The Financial Markets Advisory group, the BlackRock team that the FDIC hired, is a clean-up crew for financial crises that worked for the US government during the global financial crisis as well as during the outbreak of the pandemic in 2020. The $114 billion portfolio was the biggest the FDIC had ever found itself with in short order from failed banks.
When the FDIC disposes of assets, it conducts a competitive sales process to ensure it gets as much money as it can for them. It also looks to preserve the availability and affordability of homes for people with low- and moderate- income.
The $12.7 billion in assets that the FDIC would look to offload are a kind of bond backed by pools of Ginnie Mae Project Loans, or GNPLs. The loans underlying the bonds are taken out by developers from banks and other lenders, often to build or renovate apartments. The resulting homes are usually for low- or moderate-income families, and the loans carry penalties for early payment.
Investors have a limited appetite for these bonds.
“You risk overwhelming the market,” said Mary Beth Fisher, a fixed-income strategist at Santander. “The overall size is nearly as large as the average yearly issuance for these types of securities.”
‘Squeezing a balloon’
The FDIC probably isn’t looking to hold the assets on its books until they mature. The government agency is designed to stabilize the banking system and doesn’t have a mandate to hold investments forever, said Walter Schmidt, an MBS strategist at FHN Financial.
Restructuring mortgage bonds is possible, but has its shortcomings. By combining bonds together and shifting their cash flows, the FDIC can create what are essentially derivative securities that might attract investors. But the underlying pool will remain the same, so making some securities safer for money managers could result in the remainder being even riskier.
“You can’t make the risk go away. All you can do is redistribute it,” said Oppenheimer’s Estabrook. “It’s like squeezing a balloon. You can squeeze on one side, but if you do, the other side is going to fill up.”