Last year proved a boon for private mortgage-backed securities investors.
Nonconforming collateral, such as adjustable-rate mortgages, surged in demand and yield. Moreover, any upticks in interest rates may not impact performance due to government intervention in other areas.
Investors also returned in force to the market, with double-digit returns attracting the yield-hungry, according to recent analysis from Deutsche Bank (DB).
Barclays analysts noted that the collateral continues to perform well. "Always current-to-delinquent roll rates were lower in the ABX and PrimeX indices than last month’s levels, as well as three-month prior levels," said Barclays (BCS) researchers in a note to clients, referring to the bond market indices that track nonconforming mortgage products.
Considering that the majority of these mortgages structurally change when interest rates inch higher or lower, bond market players are watching closely.
"Non-agency MBS investors should be mindful of their exposure to rising rates given the record low interest rate environment, along with an improving US economy and housing market, and dovish comments from the FOMC minutes on a potential end to QE in 2013," said the Deustche Bank analysts, in a note to clients.
"Rising interest rates typically result in rising delinquency rates among ARM loans and declining value in fixed-rate MBS," they add.
However, the exposure of ABX and PrimeX to changing interests rates are not as bad as could be. Deutsche Bank estimates around 40% of the pool in these markets are ARMs.
If it were not for aggressive mortgage modifications by servicers and government-backing, ARMs would comprise closer to 63% of these pools, they said.