Uncategorized
Sell CRT B1s and rotate into other mortgage credits
admin | June 12, 2020
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 recent rally in credit risk transfer securities has seen some bonds doubling in price in less than a month. While there are reasons to be optimistic that COVID-19 related defaults and losses may be contained, bonds further down in the capital structure may have limited upside at this point, even to fairly rosy scenarios, and likely have much greater downside to harsher stresses. Sell CRT B1s and rotate into other areas of mortgage credit.
A sharp rally in CRT
The recent risk on trade in mortgage credit has been most pronounced in certain corners of the GSE CRT market. Certain late vintage B1 classes have roughly doubled in price over recent weeks in spite of an absence of timely, specific performance data to support what appears to be a fairly seismic shift in investor sentiment about the potential tail of virus-related defaults and losses (Exhibit 1).
A confluence of factors has likely fueled the rally:
- Faster than anticipated prepayment speeds over the past two months
- A slowdown in forbearance uptake by borrowers
- Relatively robust housing data
- The enterprises’ announcement that debt burdens on borrowers coming out of forbearance will likely be eased as missed payments can be deferred to maturity without accruing interest, and
- Attractive carry at current valuations given the lag in defaults and losses associated with loans currently in forbearance
Exhibit 1: Month-over-month percent price change across CRT B classes
Source: Vista, Amherst Pierpont Securities
There is still significant uncertainty around the impact of COVID-19 on GSE borrowers. Terminal rates of unemployment will undoubtedly be higher, and it’s unclear what the population of those unemployed may look like. A second wave of outbreaks could drive an additional spike in forbearance. Additionally, fast prepayment speeds that serve to deleverage these pools and shorten the deals may in fact be pulling forward the tail of adversely selected borrowers still remaining in the pool as better borrowers prepay.
A look at current upside and downside
It makes sense to look at both where relative value may lie in base, bull and bear scenarios. It appears most of the B1 universe would have asymmetric downside to a material deterioration in fundamental performance.
It appears that the biggest potential unknown in CRT is the rate of borrower default after forbearance. The market has likely taken some comfort in strong borrower performance after exiting forbearance in the wake of recent natural disasters. However, borrowers affected by COVID-19 may not exhibit similar performance. The virus has longer lasting and more widespread effects.
The analysis assumes a baseline 2% monthly delinquency rate for six months for an average loan in forbearance and a 25% roll to liquidation assumption. Default rate multipliers overlays are then applied for attributes such as loan size, geography, FICO and LTV, derived from recent specified pool performance data. Based on these assumptions, later vintage high LTV transactions appear to offer the most nominal spread while more seasoned low LTV deals offer the least. Deals that trade the widest look to offer roughly 200 bp more spread than those that trade on the tighter end of the range. (Exhibit 2)
Exhibit 2: Later vintage high LTV B1s offer the widest nominal spread
Source: Vista, Amherst Pierpont Securities
Wider spreads may be a function of elevated uncertainty with regards to the potential future performance of late vintage high LTV borrowers. If these borrowers exit forbearance and are unable to resume their previously scheduled monthly payments, they will likely need a permanent or flex modification. Given the modification waterfall employed by Fannie Mae and Freddie Mac, higher WAC, high LTV 2019 vintage borrowers may be subject to rate modifications. The interest shortfalls between the original and modified rate would flow through as a principal loss to the junior-most bond in the capital structure on a monthly basis. And these higher WACs in these pools that been generally viewed as a positive to bondholders as they have been the driver of elevated prepayment rates, may turn out to be a credit liability if a large swath of these borrowers ultimately receive permanent modifications.
Holding spreads constant and shifting the roll-to-liquidation assumption to just 10% of borrowers who go into forbearance has a fairly negligible impact on most of the universe and only has an outsized impact on certain off-the-run classes, which the model sees as already trading nominally tight at current valuations. That suggests that absent forbearance and delinquency rates levelling out over the next few months, CRT B1 classes may have already traded back to their full fair value. Conversely, increasing the forbearance assumption to 3% per month for six months with a 50% roll-to-liquidation shows the entire universe has asymmetric downside to higher forbearance and liquidation assumptions. (Exhibit 3)
Exhibit 3: The CRT B1 universe appears to have limited upside at current prices
Source, Vista, Amherst Pierpont Securities
This asymmetry suggests that absent forbearance and delinquency rates levelling out over the next few months the overwhelming majority of the CRT B1 universe may be trading at or near fair value, with limited upside. Other areas of mortgage credit may offer a more favorable balance of upside return and downside risk.
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 © 2025 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.
Important disclaimers for clients in the EU and UK
This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).
The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.
This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.
This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.
This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.
