After widening significantly through the first half of the year to levels not seen in over a decade, Agency Mortgage spreads have tightened through the end of 2023. Despite this, when viewed against a softening economic backdrop, resilient corporate credit spreads and room for further spread compression, we maintain that exposure to the sector remains attractive. Net supply is projected to drop 40% - 50% due to higher mortgage rates and less bank selling1 which will relieve the pressure on the money management community to support spreads. This supply technical together with interest rate stability, lower volatility and renewed demand from banks is expected to further support spread levels. As previously noted, mortgage backed securities (MBS) remain historically wide to investment grade corporates, and we believe offer an excellent vehicle to reduce credit exposure while maintaining carry within a portfolio.
Figure 1: MBS Spreads against Investment Grade Corporates
Sources: Bloomberg, Credit Risk Transfer Sector (CRT)
Credit risk transfer (CRT) securities2 offer another avenue to diversify portfolios. CRT was one of the best performing sectors in the securitized market in 2023 and we still believe there is room to outperform due to favorable supply/demand technicals and a strong housing market. High mortgage rates and tepid housing turnover are expected to keep 2024 issuance equal to 2023’s at $9 billion, yet remain less than half of 2022 issuance when low rates contributed to heavy supply. In addition to low issuance, we expect Fannie Mae and Freddie Mac to continue tendering bonds (2023 amounted to $5.6bn tendered) 1-2pts through current market levels. This makes economic sense for the GSEs (Government Sponsored Enterprises) because seasoned vintages such as 2019-2021 contain underlying collateral with 10% - 40% embedded home price appreciation. Lastly, we believe significant relative value opportunities continue to exist within CRTs. For example, B1s are historically cheap to BB high yield, and we expect this spread to continue to compress.
Figure 2: Relative Value Opportunities Between CRT B1 and BB High Yield
Source: International Data Corporation (IDC) and Bloomberg
1 Source: JP Morgan 2024 Securitized Products Outlook, November 21, 2023.
2 Credit risk transfer securities were created in 2013 by two government sponsored enterprises (GSEs), Freddie Mac and Fannie Mae, to transfer the credit risk within pools of conventional residential mortgage loans from the GSEs to the private sector.
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COMPARISONS TO AN INDEX
Comparisons to a financial index are provided for illustrative purposes only. Comparisons to an index are subject to limitations because portfolio holdings, volatility and other portfolio characteristics may differ materially from the index. Unlike an index, individual portfolios are actively managed and may also include derivatives. There is no guarantee that any of the securities in an index are contained in any managed portfolio. The performance of an index may assume reinvestment of dividends and income, or follow other index-specific methodologies and criteria, but does not reflect the impact of fees, applicable taxes or trading costs which, unlike an index, may reduce the returns of a managed portfolio. Investors cannot invest in an index. Because of these differences, the performance of an index should not be relied upon as an accurate measure of comparison.
RISKS OF INVESTING IN ASSET AND MORTGAGE-BACKED SECURITIES
One of the principal risks of mortgage-related and asset-backed securities is that the underlying debt may be prepaid ahead of schedule if interest rates fall, thereby reducing the value of an investment. If interest rates rise, there is less prepayment risk but defaults may increase, potentially causing losses. This is not a complete list of risks associated with the strategy. Consult your professional advisors for further guidance.
source information
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