May 17, 2018
Healthy housing fundamentals, improving borrower credit performance, and negative net supply helped non-Agency RMBS shrug off broader market volatility in the first quarter and supported the uninterrupted trend of credit spread tightening that began in the second quarter of 2016. The non-Agency RMBS market continues to function at an institutional scale with approximately $650 billion outstanding and annual trading volume of 15–20 percent of outstanding balance. New issue in RMBS has picked up to $50 billion to $70 billion per year in recent years, but this supply has merely offset paydowns arising from prepayments, defaults, and amortization, leaving investors with a relatively stable pool of reinvestment opportunities. First-quarter new issuance totaled $12 billion, with an increased number of prime jumbo sponsors lured to the market by established securitization execution and a historically low pricing discount to Agency MBS passthroughs. Relative to 2017, we expect higher issuance of 2.0 prime and nonqualified mortgage RMBS and a reduction in non- and re-performing (NPL/RPL) mortgage-backed issuance.
New issue in RMBS has picked up to $50 billion to $70 billion per year in recent years, but this supply has merely offset paydowns arising from prepayments, defaults, and amortization. Investors have been left with a relatively stable pool of reinvestment opportunities.
Source: Wells Fargo, Guggenheim Investments. Data as of 3.31.2018.
Non-Agency RMBS recorded strong performance in the first quarter, posting a 1.7 percent total return, outperforming the Bloomberg Barclays U.S. Aggregate Bond index and most other fixed-income subsectors. Trading volume increased in January and February from the seasonal lows of December 2017 but tapered to below $2 billion per week in March. The more credit-sensitive Option ARM and subprime-backed subsectors posted the strongest performance as investors showed comfort with paying higher prices for improved expected future cashflows.
Non-Agency RMBS spreads reached post-crisis tights in the first quarter, with more credit-sensitive sectors performing the best. The flat credit curve gives little compensation for increased spread duration, subordination, or idiosyncratic event risks. Low supply creates incentives for investors to compromise security selection and credit standards and gravitate toward higherrisk trades. We remain vigilant for such underwriting “creep” and continue to favor shorter-maturity, structurally senior tranches for their lower prospective price volatility, as well as passthroughs backed by credit-sensitive collateral types, which should benefit from improving credit fundamentals.
Non-Agency RMBS spreads reached post-crisis tights in the first quarter, with more creditsensitive sectors performing the best. The flat credit curve gives little compensation for increased spread duration, subordination, or idiosyncratic event risks.
—Karthik Narayanan, CFA, Managing Director; Eric Marcus, Director
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