Goldman Sachs bought up mortgage bonds during a wave of panic selling last month, a bet that’s almost certainly made money since the Federal Reserve unveiled massive stimulus turning a crash into a rally.
The Wall Street giant amassed mortgage-backed securities from funds that had bought them with borrowed money and needed to sell quickly, according to people familiar with the matter, who asked not to be identified because the details are private.
Goldman charged a fee for helping funds and investments trusts exit repurchase agreements and it also stood to gain if the bonds rallied in the period it held them. For the funds, the trade offered a way to free up cash and escape the pain of daily margin calls in a fast-falling market, the people said.
“Making markets -- buying from or selling to our clients -- is the core activity of our Global Markets division, and we do it regardless of markets conditions,” Goldman Sachs said in a statement, adding that “we had no advance knowledge of any of the facilities the Fed announced and assumed risk when we bought securities from clients during this period.”
The high-risk bet proved to be well timed. Not long after, the Fed intervened to calm market panic and said it would buy unlimited amounts of Treasury bonds and mortgage securities. That allowed Goldman to sell some notes to the Fed, one of the people said, while even bonds that were ineligible for central bank purchases rallied after the Fed stepped in.
The Bloomberg Barclays Mortgage-Backed Securities Total Return index of the agency mortgage bonds that the Fed is buying has gained more than 3% in the last month. A Markit iBoxx benchmark of non-agency securities gained 14% over the same period.
Goldman was able to find a plentiful supply of willing sellers because the mortgage bond market is dominated by investors using leverage to amplify their positions. While buying mortgage-backed-securities using borrowed money with just a small percentage as a down payment can enhance potential profits, when asset values drop the creditor lending that money can suddenly demand a higher percentage, resulting in margin calls and a wave of forced liquidations.
And that’s exactly what happened last month when the coronavirus credit meltdown reached the U.S. mortgage market, causing prices for bonds secured by home loans to collapse and spurring a chaotic rush to offload the bonds to meet redemptions and mounting margin calls. Some investors, including a number of real estate investment trusts, said the precipitous drop in the value of the securities meant they were unable to meet margin calls and even asked counterparties for forbearance agreements.
Goldman executed a few large trades with key clients and also approached several other structured credit hedge funds to see if they wanted to trade, said the people. The firm saw an increase of as much as 75% compared to regular volumes for similar trades as of early April, one of the people said.
Even before the Fed unveiled a sweeping package of measures to address the economic damage of coronavirus lockdowns, Goldman was confident it could find buyers for any bonds it took on and wouldn’t need to warehouse them for a long period, according to one of the people. Still the Fed’s timing was fortuitous.
The central bank announced last month it’s buying unlimited amounts of mortgage securities to keep borrowing costs low, although it excluded the private U.S. mortgages that are packaged into non-agency mortgage-backed securities. It also set up programs to ensure more credit flows to businesses and expanded its Money Market Mutual Fund Liquidity Facility. After the announcement Goldman also bought securities from money market funds to sell to the Fed, one of the people said.