Amherst advises selling subprime, buying option ARMs

It’s a great time for investors to sell subprime bonds and buy option adjustable-rate mortgages, according to Amherst Securities Group. Analysts in the firm’s MBS Strategy Group said the prepayment reduction on the subprime security is likely larger than on option ARMs, “thus cutting into the excess spread.” “The cash flow uncertainty is much higher in the sub-prime sector and yields are much lower,” analysts said in the Amherst Mortgage Insight note. “Rarely does the market afford investors this obvious an opportunity, so do take advantage of it.” Analysts said predicting cash flows in MBS “has become increasingly difficult,” especially in subprime where it’s much higher on senior tranches compared to super-senior pay option ARMs, and liquidation lags are a greater concern, as well. Modifications also impact subprime mortgages “much more than option ARMs, as the reduction in gross [weighted average coupon] is larger, causing an overestimation of subprime cash flows,” according to Amherst. Analysts said models used by Amherst calculate the two major sources of slippage – the loan servicer isn’t advancing or the servicer modified the loan and has recaptured previous advances – in a way other firms don’t. Write to Jason Philyaw.