Non-Agency Residential Mortgage-Backed Securities: Volatile Prices Mask Improving Fundamentals
Improving fundamentals, lower bond prices, and limited supply form a constructive thesis for non-Agency RMBS.
This sector report is excerpted from the Second Quarter 2016 Fixed-Income Outlook.
Non-Agency RMBS credit fundamentals continue to improve. The 30 percent national home price recovery from the trough in 2012 through February 2016 has resulted in 86 percent of non-Agency RMBS loans with positive home equity, as compared to a dismal 30 percent in the darkest days of the housing crisis. Improving borrower equity and the passage of time has allowed previously delinquent borrowers to “cure” their personal finances, as evidenced by strengthening default and prepayment performance. These trends are meaningful to investment performance as the RMBS universe is increasingly re-performing in nature.
Credit Trend of Re-Performers Continues to Improve
Credit curing, improved economic conditions, and home price appreciation have generated improved default and prepayment characteristics for re-performing mortgage borrowers, underscoring our constructive view on the mortgage sector.
Source: Amherst Securities. Data as of 2.29.2016.
After producing positive returns for 2015, the non-Agency RMBS market succumbed to broad market volatility in the first quarter, returning -0.9 percent, according to Citigroup. Performance turned positive in March, but lagged the dramatic rally in other credit sectors. Looking ahead, we expect RMBS bond prices to takes cues, on a time-lagged basis, from broader credit markets. Ongoing market volatility could provide opportunities for disciplined investors to benefit from improving housing and borrower credit fundamentals, lower bond prices, and limited supply. Market volatility has dampened the already limited issuance of non-Agency RMBS. New issuance has totaled approximately $9.7 billion year to date, offsetting only 40 percent of the $24 billion in year-to-date pay downs of the $680 billion RMBS market. We believe that this supply shortage creates a favorable market technical for investment performance.
One of our favored RMBS subsectors is floating-rate senior re-securitizations backed by distressed pre-crisis tranches. Such repackagings can be backed by single or multiple underlying tranches, are rated or unrated, and generally offer significant added credit protection. At 2.9–4.2 percent above their corresponding benchmark rates, their yields are attractive relative to those on the underlying RMBS tranches, especially considering the higher credit enhancement and shorter maturities offered by the re-securitization. We continue to favor pre-crisis Alt-A and subprime tranches and select non-performing/re-performing deals. Additionally, we avoid long maturity and subordinated bonds for their high volatility and weak sponsorship as well as prime collateral-backed deals with their lower yields and limited credit optionality.
Re-Performers Comprise a Growing Part of Non-Agency RMBS Market
The composition of the non- Agency RMBS collateral is shifting toward re-performing borrowers— an important trend as previously delinquent borrowers continue to cure their credit scores and improve personal finances.
Source: Amherst-Pierpont Securities, JP Morgan, Guggenheim Investments. Data as of 2.29.2016.
—Eric Marcus, Director; Karthik Narayanan, CFA, Director
Important Notices and Disclosures
This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.
Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment-grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating-rate senior-secured syndicated bank loans and other floating-rate securities involve special types of risks, including credit risk, interest-rate risk, liquidity risk and prepayment risk.
Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Real Estate, LLC, Transparent Value Advisors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited and Guggenheim Partners India Management.
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Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Distributors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Partners Advisors, LLC, Guggenheim Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, GS GAMMA Advisors, LLC, and Guggenheim Partners India Management.