The momentum in the private-label mortgage-backed securities market has produced a solid tone for the sector, with the largest support coming from the subprime space. 

Subprime securities continue to be the preferred sector for long-term home price appreciation and representation and warranty trends, Bank of America Merrill Lynch said in its latest report.

“In many ways, the stories that have driven the remarkable performance of the securities remain the same. Bond scarcity continues to bring investors searching for yield to the sector, while accounts continue to hesitate selling into market strength,” said Chris Flanagan, Ryan Asato and Justin Borst, analysts for BofAML (BAC).

Trading Reporting and Compliance Engine (TRACE) data shows that $7.4 billion in non-investment grade and $0.6 billion in investment graded securities traded through May 3.

While this is far from being considered robust volume, it is expected be the most active week since late February, the report added.

“Interesting, dealers have added $900 million in residential mortgage-backed securities to inventory over the last six trading days as activity picked up, but remains $2.6 billion lighter on the year,” the analysts explained.

On the fundamental side, housing continues to surprise.

The Case-Shiller data shows the average home price for its 20-city composite index increased by 9.3% for the year ending in February.

Additionally, pending homes sales climbed 1.5% month-over-month in March, which surpassed market expectations.

“We look for low inventory and greater demand to push home prices higher throughout the spring and summer seasons. Overall, we expect home prices to be up 8% this year,” BofAML said.

They added, “While much of the upside likely has been already priced into bond valuations, we think it will continue to drive interest into the sector which could lead to further spread compression.”

Meanwhile, nonagency RMBS delivered impressive returns as prices continue to trend higher and fundamental performance remained stable.

The higher quality prime and alt-A security sector continue to be supported by principal and interest returns.

“Investors attracted to the higher yielding securities continue to bid up the more distressed collateral, leading to additional capital returns for bonds where cash flows are oftentimes minimal,” the analysts explained.

They concluded, “Subprime bonds continue to garner the most attention in the market particularly long duration bonds tied to the recovery in home prices.”

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