Investments

Credit risk transfer bonds rise to one of best performing debts of 2017

Popularity could grow in 2018

One of the top bond trades of this year is expected to continue, and even become more popular in 2018 as more and more traders bet that homeowners won’t default of their mortgages.

Earlier this year, at the Mortgage Bankers Association National Secondary Market Conference and Expo in New York City, panelists gathered to speak on the credit risk transfer market, predicting that the housing market would see more capital come into the space in the next three to five years.

In order to reduce risk for American taxpayers, Fannie Mae and Freddie Mac created programs that allow reinsurers to cover part of a loss in case of borrower defaults.

And these programs have performed well over 2017. In November, Fannie Mae closed its ninth and final risk transfer of the year, marking a total $5.3 billion of insurance coverage of about $220 billion in loans through its CIRT program.

And these investments will pay off for investors as the Federal Reserve continues to project three interest rate hikes in 2018, according to an article by Claire Boston for Bloomberg.

From the article:

Money managers piled into relatively new Fannie Mae and Freddie Mac bonds known as "credit risk transfer" securities in 2017 in part because they are floating rate, a boon when the Federal Reserve is projecting three rate hikes in the coming year. Investors who bought subprime mortgage bonds after the housing crisis for pennies on the dollar are now getting repaid about $80 billion of principal a year, and are looking to reinvest their funds somewhere.

“It’s been an incredible year for the space,” said Dave Goodson, who heads mortgage-backed securities and related bonds at Voya Investment Management, which manages $230 billion. “It’s becoming better and better established. We like that.”

Bank of America data shows the riskier credit-risk transfers returned more than 10% through December 1, 2017. Next year, portions of the bonds could return 3% on top of government debt, a Morgan Stanley analyst said, according to the article. These analysts say CRT bonds are the place to be in 2018.

From the article:

Investors buying these securities are among the first to suffer losses when homeowners fail to make their payments. But with unemployment at just 4.1 percent in November and the U.S. economy growing at an annualized rate faster than 3 percent, it seems reasonable to bet that prime borrowers will continue to pay their home loans, Goodson said. He prefers the securities to commercial real estate or corporate debt, which may face downturns sooner.

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