February 23, 2018
We maintain our long-running constructive view on non-Agency RMBS as healthy housing fundamentals and improving borrower performance support the sector. Strong demand and muted new home construction have pushed inventories to historically low levels, in turn boosting home values. Against this backdrop, ongoing credit curing of legacy MBS borrowers should result in improved prepayments and loss rates on bonds and has already emboldened greater risk-taking by lenders and investors.
The homeownership rate has risen after 10 years of declines, with gains coming from younger age groups, including first-time buyers. Strong demand and muted new home construction have pushed inventories to historically low levels, in turn boosting home values.
Source: U.S. Census Bureau, Bloomberg, National Association of Realtors, Guggenheim Investments. Data as of 1.10.2018.
Approximately $50 billion of new issuance is projected for 2018 across a variety of asset types, including non- and re-performing loans, credit risk transfer deals backed by “vanilla” government-sponsored enterprise loans, jumbo prime loans, and most recently, non-qualified mortgage (non-QM) loans. The QM rule was implemented in 2013 under the Dodd-Frank Act and stipulates a number of attributes necessary to provide legal safeguards for the lender. Loans that do not qualify for QM status tend to be investor properties, credit-blemished borrowers, first-time borrowers with higher debt-to-income (DTI) ratios, and self-employed borrowers who use bank statements to demonstrate their monthly cash income. The non-QM market is small—$4 billion outstanding—with issuance concentrated in the last 12 months, but this market is likely to grow with heightened borrower awareness and increased lender comfort around credit performance and securitization execution. Traditional MBS credit metrics of credit score and debt-to-income ratio have remained stable for non-QM to date, but the depth of originator diligence on bank statement-based loans could come under pressure if origination volumes grow significantly.
Non-Agency RMBS recorded strong performance in the fourth quarter, posting a 1.6 percent total return, outperforming the Bloomberg Barclays Aggregate index and bringing year-to-date returns to 10.5 percent. Trading volume tapered off in December while investor appetite and dealer inventory remained stable.
Non-Agency RMBS spreads have now tightened to post-crisis lows and the flat credit curve gives little compensation for bearing increased spread duration, subordination, or idiosyncratic event risks. We continue to favor senior tranches backed by credit-sensitive collateral types, which should benefit from monthly amortization and improving credit fundamentals.
Originator diligence should come under pressure if volumes of non-QM loans grow significantly. Indeed, loans to borrowers who use bank statements to demonstrate their monthly cash income are growing as a percentage of non-QM issues outstanding. FICO scores have not deteriorated as a result of this trend.
Source: Guggenheim Investments. Data as of 1.10.2018.
—Karthik Narayanan, CFA, Managing Director; Eric Marcus, Director
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