/perspectives/sector-views/constructive-on-non-agency-rmbs

Non-Agency Residential Mortgage-Backed Securities: Constructive on Non-Agency RMBS

Low new-issue volume will limit supply and provide positive technical tailwinds for the sector.

May 16, 2023


This Non-Agency Residential Mortgage-Backed Securities sector report is excerpted from the Second Quarter 2023 Fixed-Income Sector Views.

The performance for non-Agency RMBS in the first quarter reflected broader market dynamics. Due to the macro volatility related to financial difficulties of regional banks, RMBS valuations experienced some softening to end the quarter. For instance, non-qualified mortgage (non-QM) AAA tightened by 40 basis points to start the year only to retrace all the tightening by the end of March. RMBS 1.0 and RMBS 2.0 subsectors—RMBS issued pre- or post-Global Financial Crisis (GFC)—posted 0.8 percent and 1.5 percent returns, respectively, in the first quarter, according to Citigroup data. Markets have trended with less volatility in the second quarter.

From a credit perspective, headwinds created by negative price moves in the housing market after June 2022 and an impending recession are meaningfully cushioned by conservative mortgage underwriting and more than a decade of underinvestment in housing relative to population growth in the United States. Additionally, tentative indications that home prices are near a bottom further reinforce the strength of the credit profile of RMBS. The latest CoreLogic reading for the month of February showed a 0.8 percent increase in home prices nationwide. It was the first positive reading since June of 2022. The price increase comes after several months of progressively smaller declines, which reached a peak of -1.1 percent in August of 2022. If the reversal continues, the improving housing market should modestly boost housing turnover-related prepayments which in turn provide an opportunity for capital appreciation for RMBS 1.0 and re-performing MBS deals that currently trade below par.

We remain constructive on RMBS credit, and the low new-issue volume will limit supply and may provide positive technical tailwinds for the sector. We see value in non-QM RMBS 2.0 mezzanine and senior tranches with investment grade, typically stable weighted average life profiles, and RMBS 1.0 backed by loans with significant home equity. While typically carrying a low likelihood of principal loss, current investment-grade RMBS valuations reflect spreads wider than the long-run averages. These subsectors currently offer 5.5–6.5 percent yields and routinely trade at discount dollar prices.

Home Price Growth Turned Positive After Months of Declines

CoreLogic Single-Family Price Change (MoM)

The latest CoreLogic reading for the month of February was the first positive reading since June of 2022, coming after several months of progressively smaller declines. If the reversal continues, the improving housing market should modestly boost housing turnover-related prepayments which in turn provide an opportunity for capital appreciation for RMBS 1.0 and re-performing MBS deals that currently trade below par.

Very Little Industry Dispersion in the Investment-Grade Index

Source: Guggenheim Investments, J.P. Morgan, CoreLogic. Data as of February 2023.

—By Karthik Narayanan and Roy Park

 
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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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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.

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