Private-label residential mortgage-backed securities outperformed most fixed-income markets in the first half of year as rising home prices and lower interest rates made the bonds attractive to investors.

However, several key themes are going to be important drivers for private-label performance in the latter half of the year that may prove to be headwinds instead of tailwinds, according to Bank of America Merrill Lynch’s (BAC) latest report.

For instance, recent market volatility has mainly stemmed from Federal Reserve talk regarding winding down its bond-buying program before the year is out.

In response to the potential tapering of its quantitative program, nonagency jumbo-fixed RMBS yields increased beyond where they were directly before the central bank’s announcement.

However, longer duration bonds have shown a higher resistance to the sell-off seen in nonagency jumbo fixed-rate mortgages.

"We expect yields for higher dollar priced, quality bonds in the non-agency sector to face the most immediate pressure in a rising rate environment," said Chris Flanagan, Ryan Asato and Justin Borst, MBS strategists for BofAML.

They added, "However, current yields for longer duration, lower dollar priced deals will likely become more susceptible to rate moves if the spread to agency MBS and treasuries continues to compress."

Rising rates will also have a modest negative impact on private-label RMBS, but housing will continue to drive fundamental performance.

BofAML analysts believe that the housing recovery will carry on in spite of higher rates, albeit at a slower rate than the place observed in the first part of the year.

"The growing recognition that the best home price growth is behind us should increasingly weigh on expectations for future credit and prepayment performance," the analysts explained. 

Liquidity also became a problem for nonagency RMBS at the end of the second quarter as volatility crept back into the market.

Looking foward, periods of high volatility in the second half of 2013 are likely, which could push bid spreads to multi-point levels and freeze trading activity for long durations, according to BofAML. 

While private-label issuance has continued to accelerate in recent weeks despite the sharp rise in mortgage rates, pricing on such deals continues to deteriorate and, more importantly, investors interested in the securities remains limited. 

"The combination between deteriorating pricing and a slowdown in originations will likely dampen the amount of RMBS issuance that is brought to the market in the second half of the year," the BofAML analysts concluded.