This Non-Agency Residential Mortgage-Backed Securities sector report is excerpted from the Third Quarter 2023 Fixed-Income Sector Views.
Limited supply should provide a positive technical tailwind for the non-Agency RMBS sector in the second half of 2023. Net new issuance is expected to be $5–10 billion for the rest of 2023 as low origination volumes for purchase and refinance mortgage loans are expected to persist, limiting the amount of loans to be securitized. These factors, as well as the combination of a stabilizing housing market and relatively strong labor conditions, support our constructive outlook for the sector.
New issue volume totaled $30 billion as of mid-August, a decline of 67 percent year over year as elevated rates caused refinancing activity to stall. Additionally, high mortgage rates have discouraged current homeowners with historically low rates on their mortgage loans from selling their homes. Despite inflationary pressures abating, the average 30-year fixed mortgage rate was greater than 7.5 percent in mid-August, its highest level since 2000. As a result, the inventory of existing homes for sale fell to 1.08 million units in May 2023, a record low for the month, and activity slowed significantly in the residential housing market.
Non-Agency RMBS valuations benefited from the low new-issue volume as the housing market and the broader banking system showed signs of stabilization. However, they lagged the spread tightening experienced in more liquid credit markets. For instance, the five-year Bloomberg U.S. Investment-Grade Corporate Bond Index retraced three-fourths of its credit spread widening in the wake of the Silicon Valley Bank collapse, but non-qualified mortgage (QM) AAA RMBS retraced less than half of their credit spread widening over the same period, leaving potential for positive total return over time in a normalizing spread environment.
Current RMBS valuations reflect spreads wider than the long-run averages. We prefer AAA–A rated non-QM RMBS 2.0 mezzanine and senior tranches with stable weighted average life profiles, and RMBS 1.0 backed by loans with significant home equity. These subsectors have offered yields in the 6–6.5 percent range and have routinely traded at discounted dollar prices, which is rare for the sector and improves their total return profile.
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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.