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Mining for relative value in prime pass-throughs

admin | August 2, 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.

Despite the explosive increase in prepayment speeds across certain private MBS cohorts, the pass-through market still trades with very little price difference across coupons, vintages and collateral stories, effectively painting different collateral stories with the same brush. Using the agency specified pool market as a guide suggests that certain collateral stories in prime pass-throughs may be significantly mispriced.

Investor 4.5% pass-throughs offer significant relative value

Private MBS agency-eligible investor pass-throughs trade at significantly wider nominal spreads than agency pools despite very similar collateral
Higher coupon investor pools trade to higher pay-ups in agency space, while higher coupons do not get the same price premium in private MBS space
As a result, investor 4.5% pass-throughs appear to offer some of the most attractive relative value across private MBS (Exhibit 1)

Exhibit 1: Investor 4.5% offer attractive relative value

Source: Bloomberg, Amherst Pierpont Securities

Looking at the relationship between investor 4.0% and 4.5% private pass-throughs in comparison to agency investor pools shows not only a large spread differential between the two but a potentially directionally mispriced spread relationship. Investor 4.0% pass-throughs trade at $1-00 back of TBA while similar loans in agency space trade nearly $0-16 higher than TBA. Liquidity and financing could explain some of the spread difference, but there are examples where private label pass-throughs trade through agency execution. Additionally, higher coupon investor pass-throughs trade tighter in agency space with 4.5% coupons trading at a 4/32 greater pay up than the 4.0% cohort. Conversely, higher coupon private investor pass-throughs trade roughly $0-20 below the comparable 4.0% cohort, suggesting that 4.5% investor pass-throughs may be the best source of relative value in prime pass-throughs.

While there are structural differences between the investor pass-through and the agency pool, the collateral profiles are substantially similar given that these are agency-eligible investor loans that had better private label execution relative to an agency guarantee fee and associated loan level pricing adjustments. As such the nominal cheapness in the investor 4.5% equates to an additional 16 bp of OAS on the investor pass-through despite the more levered cash flow structure. (Exhibit 2)

Exhibit 2: Investor 4.5% offer more OAS than investor pools

Source: Yieldbook, Amherst Pierpont Securities

Investor pass-throughs and CK 4.0% pools offer significant relative value to. prime jumbo 4.0%

The spread between agency investor and prime jumbo 4.0% pass-throughs is extremely tight despite markedly slower speeds in investor loans
The spread between CK and prime jumbo pass-throughs is inverted despite better liquidity and financing terms in agency pools
Spreads on newer vintage 4.0% pass-throughs have not widened materially despite some deals paying in excess of 60 CPR in June (Exhibit 3)

Exhibit 3: Investor & CK 4.0%s offer attractive RV versus jumbo

Source: Bloomberg, Amherst Pierpont Securities

Through the recent rally in interest rates, investor collateral has by and large paid substantially slower than jumbo collateral. Despite this, 4.0% pass-throughs trade just 4/32 inside of their prime jumbo counterparts, given the relatively tight basis investor pass-throughs should offer significantly more call protection, given their historically flatter S-curve, than prime jumbo. (Exhibit 4)

Exhibit 4: Prime private label investor loans have flatter S-curves than jumbo

Source: Amherst Insight Labs, Amherst Pierpont Securities

Private 4.0% pass-through spreads appear to be anchored by levered investors looking for higher yields as the 4.0% TBA benchmark trades wider on the curve than 3.5%s. Despite this, there is a substantial spread in the pay up between new production conforming jumbo 3.5% and 4.0% specified pools. Fannie Mae CK 3.5% trade roughly 20/32s tighter than the 4.0% cohort. Additionally CK 4.0’s trade nominally wide to 4.0% new production prime jumbo pass-throughs at roughly $1-10/32 back of TBA, potentially a function of generally higher GWACs on agency production, but should still push levered players into CK 4.0s given wider spreads, more favorable financing terms and better liquidity in the agency pool.

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john.killian@santander.us 1 (646) 776-7714

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