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Anchoring a barbell with long duration RPL MBS

| July 12, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Given the current inversion in the front end of the yield curve, some investors are looking to pair floating rate assets with long fixed rate bonds as substitutes for intermediate cash flows. The paired cash flows often offer better projected yield, convexity and potential return. While some investors have gravitated to agency CMOs or CMBS to anchor the long end, long private MBS backed by nonperforming loans should be on the list, too, especially with prepayment risk on the rise.

TPMT 2019-2 M1 is a good example of private MBS backed by seasoned re-performers with potential return advantages over longer duration agency bonds. The TPMT bond benefits from better convexity than the CMO, driven in part by the significant amount of securitized forbearance. At issuance, 11.9% of the loans backing the 2019-2 deal were non-interest bearing. That balance has grown to 12.3% as of June and is one of the largest concentrations of securitized forbearance across the Towd Point shelf. Securitizing forbearance drives the effective WAC and potential refinancing incentive lower since forbearance constitutes a loan at a 0% interest rate. And as the deal continues to season and the loans amortize, and proportional amount of forbearance grows. (Exhibit 1)

Exhibit 1: Loans with forebearance prepay significantly slower in RPL deals

Source: Amherst Insight Labs, Amherst Pierpont Sample is exclusive to TPMT shelf

The TPMT bond compares favorably to LCF agency CMOs like FNR 2019-28 CB as it offers 55 bp more nominal spread and an additional 60 bp of OAS than the agency LCF (Exhibit 2). The bond is roughly three years shorter in duration than the LCF, partially driven by the fact that the TPMT bond is a premium with 75 bps more coupon than the LCF. Despite the greater amount of IO in the TPMT bond, it has better convexity than the agency CMO.  And despite comparable WACs, the TPMT bond is expected to pay roughly 10 CPR slower than the agency LCF, likely a function of the large amount of securitized forbearance.

Exhibit 2: Risk and return in RPL ‘A’ versus agency LCF

Note: All market levels are as of COB 7/10/19. Source: YieldBook, Amherst Pierpont Securities

The Towd Point bond potentially delivers better total returns than a duration-neutral combination of agency CMO floaters and CMO last cash flows (Exhibit 3). The TPMT ‘A’ significantly outperforms the CMO barbell across a 50 bp rally to a 50 bp selloff and modestly outperforms the pair up and down 75 bp. Once we pair the LCF with a positively convex CMO floater the combination has modestly better convexity than the TPMT bond and the paired trade slightly outperforms the RPL  ‘A’ into a 100 bp rally or sell off. (Exhibit 3)

Exhibit 3: RPLs ‘A’s outperform an agency barbell across scenarios

Note: Total returns assume linear parallel shifts over 12 months, reinvestment at 1-month LIBOR and horizon repricing at constant OAS. All market levels as of COB 7/10/19. Source: YieldBook, Amherst Pierpont Securities

One other advantage of RPL ‘A’ bonds is scale, while agency LCF can generally be relatively small, RPL ‘A’ classes can often be upwards of $100 million depending on the size of the deal.

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