As the 10-year Treasury rate hit historical lows in the third quarter, concerns arose that the Agency MBS market would revisit its 2012 refinancing wave. However, the borrower incentives needed to reach the same prepayment levels did not exist: Public data releases reflecting borrower prepayment behavior lag actual interest-rate moves by over a month and the subsequent data demonstrated the impact was much less than previously witnessed at similar rate levels. The impact of prepayments is the primary risk driver that determines the spread over similar U.S. government-backed paper, and the spread tightening that followed the data release reflects this increasingly manageable risk. While concerns over prepayment risks are diminishing, there are still questions regarding the Fed’s portfolio, which contains approximately 30 percent of the entire Agency MBS market. A renewed focus on the possibility of a faster pace of hikes could reignite market speculation over the potential that the Fed will sell assets from its current portfolio. Notwithstanding this concern, spreads have moved toward the lower end of the past three years as some investors are calling for up-in-quality asset positioning into a rate hike environment. A technical picture supported by seasonal supply declines, sluggish growth in credit availability, and the aforementioned diminishing levels of prepayment risk are also driving this strong performance.
After strong returns in the first and second quarters, MBS had another positive total return of 0.6 percent in the third quarter of 2016. Spreads tightened 7 basis points to 99 basis points in the third quarter, while yields were roughly unchanged. Current yields of 2.1 percent are roughly 20 basis points higher than the lows in 2012.
We prefer a combination of TBA FNMA 30 years and moderate pay-up loan balance pools. Investors can take advantage of roll financing and liquidity in the TBA stack where the Fed is focusing most of its buying. Select loan balance pools priced no more than 1 point above their respective TBA coupons provide a good balance between carry and prepay protection. We would avoid most premium-priced LTV pools. Steady home price appreciation has eroded the protection initially afforded to these bonds. Many of the underlying borrowers can now refinance and lower their loan payment by eliminating the mortgage insurance fee assigned to the loan whose LTV originally exceeded 80 percent.
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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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.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim").
Guggenheim Funds Distributors, LLC is an affiliate of Guggenheim.
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*Guggenheim Investments total asset figure is as of 12.31.2016. The assets include leverage of $12.3bn for assets under management and $0.4bn for assets for which we provide administrative services.
Guggenheim Investments represents the investment management businesses of Guggenheim Partners, LLC ("Guggenheim"), which includes Security Investors, LLC ("SI"), Guggenheim Funds Investment Advisors, LLC, ("GFIA") and Guggenheim Partners Investment Management ("GPIM") the investment advisers to the referenced funds. Securities offered through Guggenheim Funds Distributors, LLC, an affiliate of Guggenheim, SI, GFIA and GPIM.
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