By Nick Childs
Securitized Products Analyst Nick Childs examines borrower and lender behaviors to ascertain where value exists and where mortgage-backed securities (MBS) can fit into a fixed income portfolio in a rising rate environment.
The lion’s share of the mortgage market is predominantly agency mortgages. When we refer to agencies, we are referring to Fannie Mae, Freddie Mac and Ginnie Mae. The agency mortgage market in general is around 6.5 trillion today, and it is the third-largest fixed-income market in the United States.
The days of subprime mortgages or option ARM mortgages are well behind us. In 2005, 40% of the universe was these agency mortgages. Today it is approaching 70%, around 65% and growing.
Today there are various different programs that Fannie and Freddie are offering to borrowers. These new programs include home-ready program, home-possible program. So with these loans, borrowers can effectively put as little as 3% down today, which is more traditional to the Ginnie Mae space, but Fannie and Freddie are kind of accessing those borrowers and taking a larger market share.
Today people are concerned about credit risk. There is more issuance in the market than there has been, there is more high yield and durations have been extending. Agency MBS is a shorter-duration asset. For that reason, it bodes well to investors that are concerned about credit risk, concerned about risks broadly, as well as concerned about interest rate risk.
The agency MBS universe in general is ideal for active management. You have a $6.5 trillion universe, you have an enormous amount of liquidity. You know, the other issue with agency mortgages is it is the second-most liquid market in the United States. So you have all these nuance-specific, very niche kind of market specialties around that space, but at the same time, you can access the space in a very liquid, high-paced manner.
Non-agency mortgages, it is a bad word coming from the housing crisis, right? Subprime, everybody knows all about it, there is a movie about it. But non-agency today is extremely different. These are high-quality borrowers - think 780 FICO - so jumbo borrowers, higher loan size. The loans that were originated in past years that have accumulated home price appreciation, so effectively built up equity in the home, so very little to any credit risk. We would argue no credit risk. And it is more an agency-like product. Those offer significant value versus agency MBS, and they trade in a similar fashion.
In the credit risk transfer space, these are Fannie and Freddie securitizations. These are effectively the insurance that they are selling to the private market. Some of the more seasoned issues have delevered and have very little credit risk at this point. Most of those assets have been, are being, upgraded today because of their performance. The newer production CRT, where they have higher LTVs and we do believe that into a moderate housing downturn, do have substantial credit risk.
The Fed came into the year owning around a third of the agency mortgage universe, believe it or not. So, 1.75 trillion. Today they are reducing their balance sheet. We have seen widening year to date, and today, given supply issues, we believe agency mortgages are fair value. The other thing that is interesting today is the cash-out share of refinances is increasing. We are at, in terms of refi, 70% today is cash-out refi. So, this is another example of kind of loosening underwriting standards.
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