Uncategorized
Anchoring a barbell with long duration RPL MBS
admin | 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. This material does not constitute research.
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.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
