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Non-QM MBS gets the call, and the negative convexity
admin | August 16, 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.
The relentless rally to lower rates has significantly increased negative convexity in non-QM MBS trusts. The rising negative convexity comes not only from rising prepayment risk but the deleveraging associated with it, bringing deals closer to clean up calls. Lower rates have also has pushed collateral prices higher, driving par priced date calls deeper into the money.
The par clean-up call looks executable on nearly the entirety of the universe of non-QM MBS deals, with the option as much as five points or more in the money. Four trusts, AOMT 2017-1 and 2017-2 and VERUS 2017-1A and 2017-2A, totaling more than $325 million par balance, are likely to get called this month. (Exhibit 1)
Exhibit 1: Projected call volume of non-QM trusts
Note: Collateral pricing as of 8/5/2019. Projected call based on date call and collateral price greater than par assuming a 150 DM spread to price. Source: Amherst Insight Labs, Amherst Pierpont Securities
The likelihood of call execution depends on rates and bond spreads. The recently issued DRMT 2019-3 is a fair guide to spreads on non-QM MBS. Absent risk retention requirements, the deal priced more than 98% of total liabilities, not taking into account issued interest-only bonds. The weighted average spread on DRMT 2019-3 liabilities comes to around 150 bp (Exhibit 2) Tightening liability spreads would increase the value of the par call, while widening ones would decrease it.
Exhibit 2: Calculating the cost of non-QM issuance
Note: Yields as of 8/14/19. Source: Bloomberg, Amherst Pierpont Securities
Based on this approach, the 49 deals sampled are all in-the-money, but the value of the call varies from as little as $2 some trusts to as much as $8 on others. Deals that are deeply in-the-money appear to be generally higher WAC, higher SATO trusts. These deals could become increasingly susceptible to not only a greater likelihood of being called but elevated prepayment risk assuming a credit box widening, tightening of loan spreads and WAC compression. (Exhibit 3)
Exhibit 3: Estimated collateral price of non-QM trusts
Note: Prices as of 8/15/19. Source: Amherst Insight Labs, Amherst Pierpont Securities
Called loans are likely to pop back up in newly issued non-QM trusts. In June, Caliber executed a par date call on four COLT trusts issued in 2016 and 2017. It appears those loans may have resurfaced in a recent non- QM transaction sponsored by PIMCO, BRAVO 2019-NQM1. Per a Fitch presale report, ‘more than 80% of the pool was previously securitized in transactions from 2016 and 2017 that have since been collapsed. The presale shows that loans originated by Caliber Home Loans made up 62.9% of the original pool balance, while Sterling, a frequent contributor to COLT deals, made up an additional 25.9% of the pool.
The securitizations of called loans may provide investors with some refuge from prepay risk. Given the fact that these loans are seasoned and called rather than prepaid may provide some call protection given the fact these loans have been in the money for some time but have not prepaid. While it’s too early to tell, if this proves to be the case we may see some price differentiation between seasoned deals issued by aggregators and lower WALA deals.
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