Semper remains extremely constructive on both the fundamental and technical landscape for the RMBS sector and mortgage credit
by Semper Capital, on Sep 27, 2021
We remain extremely constructive on both the fundamental and technical landscape for the RMBS sector and mortgage credit and see meaningful opportunity for continued spread tightening in the sector. The potential for meaningful continued spread compression is driven by several key themes.
- Robust Housing Fundamentals
Limited inventory created from years of underdevelopment in the housing market after the Great Financial Crisis (GFC), coupled with strong demand for shelter, brought forward as a result of the crisis, plus historically low mortgage rates have been a strong catalyst for growth in the U.S. housing market. The result has been 13% year over year home price appreciation with an expectation of more continued HPA (Home Price Appreciation) ahead. A strong housing market is extremely supportive for RMBS credit and also leads to deleveraging of collateral by lower LTVs (Loan-to-Value), reducing defaults risks and lower severities.
- Limited Supply
Due to market volatility in 2020, new RMBS supply dropped meaningfully, and the sector had negative $30 billion in net issuance for the year as the Legacy sector continued to pay down and delevering of newer issue securities rose. While 2021 is expected to have a strong pickup in supply, it’s likely just enough to offset the lower supply from 2020. The lower supply environment has been met with strong demand for RMBS from investors, leading to a strong technical tailwind for the sector. In addition, newly originated collateral backing many of these newly issued deals has had some of the strongest underwriting and credit metrics seen in the sector over the last several years, as lenders tightened lending standards in response to the COVID crisis.
- Supportive Policy and Strong Credit Performance
Throughout the crisis the U.S. government and FHFA (Fannie Mae’s and Freddie Mac’s regulator) have offered continued policy support to homeowners, providing stimulus and unemployment benefits, relief from payments and other supportive policies as the U.S. economy has gradually reopened. As a result of these actions, mortgage credit has continued to perform well, and future losses related to the crisis are expected to be minimal across the various RMBS sub-sectors.
- Prepayments and Delevering
One of the key benefits of RMBS is that as deals season both the collateral and the structures delever, improving bonds’ credit and further protecting against potential loss. As borrowers pay down their mortgages, the loans delever through amortization as well as through home price appreciation, lowering the overall underlying LTVs of the deal. For example, the CRT deal STACR 2015-DNA3 had an LTV at issuance of approximately 74%. Today the LTV is under 47%, resulting in over 50% equity for borrowers in their homes. In addition to that, this same deal, through amortization and prepayments has paid down considerably and now the Last Cash Flow bond in the deal, which originally had 1% of credit enhancement and was rated B by Fitch and DBRS, now has about 4% credit enhancement and has been upgraded to A+ and A by Fitch and DBRS respectively. As a result of the delevering of both the collateral and structure, the bonds trade at a much tighter spread than the spread at the time of issuance, representing an important source of additional total return through roll down and upgrade potential for RMBS securities.
Opinions expressed in this document represent the views of Semper Capital Management, L.P., are valid only as of the date indicated, and are subject to change without notice. There can be no guarantee that any of the opinions expressed in this document or any underlying position will be maintained at the time of this presentation or thereafter. We are not soliciting or recommending any action based on this material. The information contained herein has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any securities.