Non-Agency Residential Mortgage-Backed Securities: Market in Slow Motion
Constructive themes of improving fundamentals and limited supply remain firmly in place.
Despite positive performance for the non-Agency RMBS market in the second quarter, broad market volatility dampened new issuance, which has totaled just $16 billion year to date across a diverse mix of non-performing/re-performing loans (NPL/RPL), new loans, and credit risk transfer deals. A $140 million rated securitization of non-prime loans was priced in the second quarter—the first since 2008—but issuance has only managed to offset 40 percent of the $40 billion in year-to-date pay downs of the $750 billion RMBS market. This supply shortage has normalized over time but remains a favorable market technical. Ongoing implementation of post-crisis banking regulations has created a secular decline in dealer risk appetite. Dealer inventories fell in the second quarter and stand about 50 percent lower year over year. Despite this weaker market intermediation, secondary market turnover has remained within the historical range as dealers now complete a larger portion of trades by crossing bonds between end investors.
Dealer Inventories Continue to Decline
Dealer inventories of non-Agency RMBS have declined from approximately $19 billion in 2013 to only $9 billion as of June 30, 2016, as banks continue to make progress on implementing a slew of post-crisis regulations. We believe this trend is unlikely to reverse soon as a result of increased capital requirements for banks to hold riskier assets on their balance sheets.
Source: Bloomberg, Federal Reserve Bank of New York, Guggenheim Investments. Data as of 6.30.2016.
The non-Agency RMBS market shrugged off global market volatility and returned 2.9 percent in the second quarter. Alt-A and Option ARM deals outperformed other subsectors and returned 4.1 percent. Long-running improvements in housing and borrower credit fundamentals inform our constructive intermediate-term view on the sector. Negative net supply and low dealer inventories should provide favorable technical support as well. We expect near-term RMBS performance to take cues, on a time-lagged basis, from broader credit markets.
Expectations for continued market volatily, and recent convergence of yield spreads among many RMBS subsectors, have increased the attractiveness of securities that we believe are more defensive and less credit sensitive than the overall market, including selected re-securitizations, subprime RMBS, and NPL/ RPL deals. These subsectors show stable prospective performance across a range of potential interest-rate scenarios and yield 2.5–3.3 percent above their corresponding benchmark rates. Bond performance would benefit from ongoing improvements in mortgage credit and upward rating migration over time. We await a widening of yield spreads on longer maturity/higher-risk securities in order to deploy capital to those subsectors.
Lower Trading Volume Offsets Shrinking Dealer Inventories
Despite the decline in dealer inventories of non-Agency RMBS, turnover rates (trading volume as a share of the total non-Agency RMBS market) have remained stable. Dealers have continued to facilitate Agency trades, where they cross bond trades between buyers and sellers directly rather than risking their own capital.
Source: Bloomberg, SIFMA, Federal Reserve Bank of New York, Guggenheim Investments. Data as of 6.30.2016.
—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.
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