The yield on many non-Agency residential mortgage-backed securities (RMBS) may be considerably lower than most market participants believe they are receiving, according to mortgage insight this week by Amherst Securities Group. Amherst called for market participants to “do their homework” and sell securities mis-evaluated by the marketplace, according to the insight report authored by MBS strategists Laurie Goodman, Roger Ashworth, Brian Landy and Ke Yin. “Despite the run-up in prices, many market participants remain very positive about the fundamental value in non-Agency securities. We believe that this positive stance stems from three common mistakes made in valuing these securities,” the Amherst strategists said in the report. “Once those errors are corrected, the yield on many non-Agency RMBS securities is much less than most market participants are expecting.” The report adds, “That is not to say that these securities cannot run up in price further on technical grounds – but the upside is limited.” One of the major discrepancies between the way most investors gauge the market and the way Amherst looks at it, the group says, is a particular form of forecasting. Amherst studies the transition rate of loans moving into the non-performing bucket, instead of the liquidation rate of loans moving out of the non-performing bucket — the latter of which most investors look at. “Many investors look at the remittance reports and use that monthly default rate as a proxy for how quickly the loans are going delinquent,” the strategists say. “In point of fact – the monthly remittance reports measures how quickly the loans are being liquidated.” Transition rates, on the other hand, are often higher than the current liquidation rate and provide a more representative, long-term forecast. But Amherst does not disregard liquidation rates altogether, according to the insight report. Instead, Amherst keeps an eye on the overall liquidation pipeline, realizing that loans are spending longer periods in foreclosure/liquidation. Simply noting how long the liquidated loans remain in the pipeline presents a selection bias, Amherst says. “In fact, looking at the length of time that loans spent in the liquidation pipeline will underestimate the pace of liquidations,” the strategists say. “That’s because difficult-to-liquidate loans can spend a disproportionate amount of time in the liquidation pipeline. Thus, measuring the time liquidated loans spent in the pipeline contains a selection bias, which is exaggerated due to the growing pipeline.” Lastly, Amherst divides each deal into loan buckets to form a better understanding of how different types of loans will likely behave; loans with better credit characteristics usually prepay more quickly and default more slowly than “lesser quality” loans. Investors that assume all performing loans in a pool behave identically, Amherst says, will overstate the yield on most securities. “Securities should not be valued in a generic fashion, with little attention to collateral characteristics or recent transition rates,” the strategists say. “We have also seen some bonds where the collateral is much better than generic, yet the market is not rewarding that; so such bonds can often look attractive. For the most part, however, when evaluated properly, many securities in the non-Agency MBS market look fully priced, so this is an excellent time for investors to comb through holdings.” Write to Diana Golobay.
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