This Non-Agency Residential Mortgage-Backed Securities sector report is excerpted from the Fourth Quarter 2023 Fixed-Income Sector Views.
Mortgage rates, which rose to almost 8 percent in October from a low of 3 percent in September 2021, are pressuring home purchase and refinancing activity, both of which have declined significantly. Given the constraint on supply, home prices have been resilient. Stable home prices, combined with low prepayment activity, attenuate credit risk, extension risk, and bond supply, and contribute to our overall positive view on non-Agency RMBS. This is another defensive asset class to which we have diversified exposure in our strategies.
As of August, national home prices increased 3.7 percent year over year and 5.2 percent year to date in 2023, outpacing home price appreciation through many recent historical periods despite mortgage rates reaching their highest levels since 2000. This resiliency is largely due to supply-related factors: the historically low 1.1 million units listed for sale as of August 2023, combined with an existing undersupply of housing and homeowners’ reluctance to lose their low in-place mortgage rates. The positive price moves will add further to households’ combined home equity of $32 trillion as of June 2023, and should provide a positive tailwind for credit performance for residential mortgages. Tepid transaction volumes have curtailed mortgage loan originations, which should keep RMBS new issuance low and provide a favorable technical environment for RMBS valuations. A less obvious benefit of high mortgage rates is that many RMBS deals are now pricing in low prepayments and are less likely to experience further price downside due to changing investor views on extension risk.
Among our favored trades are non-qualified mortgage (non-QM) RMBS 2.0 mezzanine and senior tranches with stable weighted average life profiles. Valuations for these securities reflect credit spreads that have retraced less than 60 percent of their credit spread widening since March 2023 versus the 85 percent retracement for the five-year Bloomberg U.S. Investment-Grade Corporate Bond Index. We also favor RMBS 1.0 and re-performing loan deals backed by loans with significant home equity. While carrying a lower likelihood of principal loss, current RMBS valuations reflect spreads wider than the long-run averages. These subsectors offered 6.5–7.0 percent yields in October and routinely trade at discounted dollar prices.
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Investing involves risk, including the possible loss of principal. Investments in fixed-income instruments are subject to the possibility that interest rates could rise, causing their values to decline. High yield and unrated debt securities are at a greater risk of default than investment grade bonds and may be less liquid, which may increase volatility. Investors in asset-backed securities, including mortgage-backed securities and collateralized loan obligations (“CLOs”), generally receive payments that are part interest and part return of principal. These payments may vary based on the rate loans are repaid. Some asset-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 and valuation risk. CLOs bear similar risks to investing in loans directly, such as credit, interest rate, counterparty, prepayment, liquidity, and valuation risks. Loans are often below investment grade, may be unrated, and typically offer a fixed or floating interest rate.
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*Assets under management is as of 3.31.2024 and includes leverage of $14.5bn. 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 Corporate Funding, LLC, Guggenheim Partners Europe Limited, Guggenheim Partners Japan Limited, and GS GAMMA Advisors, LLC.