Investors reexamine desire for private-label RMBS risk
With growing unease about the possible impact of the Federal Reserve tapering its bond-buying program, as well as uncertain market repercussions, the extended rally on private-label residential mortgage-backed securities may be over.
Although investors would have to weigh this technical factor against the growing strength in housing, there may be early indications that dealers and investors are already taking pause to reassess their risk appetite for nonagency RMBS, according to analysts at Interactive Data.
Testing the market’s appetite for legacy private-label assets, there were a couple of unusually larger nonagency commercial mortgage obligation bid lists during the final weeks of May attributed to Freddie Mac and Lloyds Banking Group, respectively.
"With a stronger fundamental outlook, driven by rising home prices, lower charge-off rates in consumer revolving credit, and a positive albeit slow improvement in unemployment, in conjunction to the asset appreciation brought on by QE-driven technicals, the broad structured products space, and nonagency CMOs in particular, was generally hovering near local highs in the days leading up to the first bid list on Freddie Mac," said analysts at Interactive Data.
Since then however, shifting views on the central bank’s wind down of its open-ended third round of quantitative easing program, as well as the larger than usual secondary supply, appeared to have strained investors overall appetite for risk.
While investors' transaction volumes rose over the month, coinciding with the Freddie Mac bid list – both for investment grade and non-investment grade – dealers’ net positions between both securities appeared to suddenly diverge with the Lloyds Bank list.
For instance, investors’ positioning jumped by a sharp $1.2 billion for investment grade securities, while non-investment grade ownership fell by roughly $2 billion, the research company noted.
"This single day’s worth of activity nearly reversed the position from the prior two weeks, leaving the Street net longer by $1.5 billion investment grade and net shorter $1.3 billion non-investment grade since early May," Interactive Data analysts explained.
The impact of excessive supply due to the back-to-back large bids wanted in competition appeared to weigh in on pressure to lighten inventory in late May.
In fact, investors continued lowering offer levels in the latter half of the month, and have not yet returned to a neutral stance as of this week.
In addition to observable pressure in dealer positions, there were noticeable differences in execution between the first and second bid lists.
For instance, the Freddie Mac list was comprised of better performing bonds relative to the Lloyds Banking Group list, as indicated by loss coverage levels, according to Interactive Data.
Additionally, not only was the Lloyds Banks list worse performing as indicated by loss coverage levels, it also contained more pay option adjust-rate mortgages as well as senior support/mezzanine tranches.