Agency Mortgage-Backed Securities: Flight Risk

Prepayment risk for recently originated mortgages remains high as mortgage rates continue to fall.

December 23, 2019


This Agency Mortgage-Backed Securities sector report is excerpted from the Fourth Quarter 2019 Fixed-Income Outlook.

The Mortgage Bankers Association Refinancing index, a leading indicator of prepayment volumes, is rising again as 30-year mortgage rates declined. While about 50 percent of mortgages are in the refinance zone, the most sensitivity to prepayment risk is concentrated in generic mortgages originated since 2018 by non-bank originators.

Low Mortgage Rates and High Refi Volumes Have Kept Focus on Prepayments

Mortgage Bankers Association Refinancing Index

The Mortgage Bankers Association Refinancing index, a leading indicator of prepayment volumes, is rising again as 30-year mortgage rates declined.

Low Mortgage Rates and High Refi Volumes Have Kept Focus on Prepayments

Source: Guggenheim Investments, Mortgage Bankers Association, Bloomberg. Data as of 9.30.2019.

These were created in the new era of automation and digitization that eases the approval process and makes streamlined refinancing possible. This is most pronounced in mortgages originated through broker channels. This fast-prepaying subset of the mortgage universe, and the continued reduction in the Fed’s balance sheet holdings, have led to deteriorating performance of worst-to-deliver collateral and cheapening of residential MBS valuations. Conversely, less-negatively convex options, such as Agency multifamily and better call-protected pools, have benefited. Looking ahead, the near-term technical picture remains challenging as supply remains high, incremental prepayment risk is elevated, and demand is uncertain. Despite these concerns, RMBS valuations near their cheapest levels in recent years may provide a positive backdrop for the sector.

The Bloomberg Barclays U.S. MBS index posted a 1.37 percent total return as mortgage rates fell and interest rate volatility picked up in the third quarter. Option-adjusted spreads were slightly wider over the quarter and are currently near the widest levels of the past six years.

Agency MBS Spreads Are Near Six-Year Wides

Bloomberg Barclays Agency MBS Index OAS

The Bloomberg Barclays U.S. MBS index posted a 1.37 percent total return as mortgage rates fell and interest rate volatility picked up in the third quarter. Option-adjusted spreads were slightly wider over the quarter and are currently near the widest levels of the past six years.

Agency MBS Spreads Are Near Six-Year Wides

Source: Guggenheim Investments, Bloomberg. Data as of 9.30.2019.

We continue to favor investments where either the collateral or structure offers some cash flow stability at reasonable spreads. Accordingly, we find select subsectors attractively priced in the current environment, including longer-maturity Agency multifamily, better call-protected pools, and some collateralized mortgage obligation structures. These investments have performed well, and we expect them to continue their performance in scenarios where interest rate volatility rises, interest rates decline sharply, or the Fed continues down the path of reducing its Agency MBS holdings.

—Aditya Agrawal, CFA, Director; Louis Pacilio, CFA, Vice President

 

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.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-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 risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. 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, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.

©2019, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


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