By the Numbers

Recent performance and relative value in CRT

| July 9, 2021

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.

Spreads in GSE CRT have tightened meaningfully over the past quarter, driven by a few factors. A slowdown in prepayment speeds has raised IO valuations on premium dollar priced bonds. And continued deleveraging and improving fundamentals have driven loss coverage multiples higher, triggering ratings upgrades and tightening spreads across most sectors of CRT. A recap of performance across CRT.

Since the beginning of April, both nominal and option-adjusted spreads across GSE CRT bonds have, on average, tightened by roughly 12%. Spread tightening across various sectors of the market has not been uniform. Spread tightening in mezzanine bonds has substantially outpaced those of subordinated bonds on a percentage basis. Nominal spreads across mezzanine cash flows have tightened by an average of roughly 50 bp, representing a 20% tightening over the past quarter, exhibiting comparable tightening of OAS. Mezzanine bonds backed by low LTV collateral have outperformed high LTV collateral in both nominal and option-adjusted terms. Average OAS on last cash flow bonds backed by low LTV collateral have tightened by more than 20% while spreads on high LTV bonds are in roughly 15%. Greater incremental tightening in last cash flows backed by low LTV collateral is likely partially driven by more meaningful increases in loss coverage, or the amount of credit enhancement bands have relative to the amount of loss the collateral pool is expected to take. Loss coverage multiples on low LTV mezzanine bonds increased from roughly 12 times expected losses in the beginning of April to more than 16 times expected losses currently, representing a 40% increase in loss coverage. Loss coverage multiples on high LTV collateral increased substantially as well, growing from 16 times expected losses to just over 19 times expected losses quarter-over-quarter.

Average nominal and option-adjusted spreads across subordinate bonds have tightened by 25 bp over the quarter, representing a 6% tightening since the beginning of April. Contrary to performance in mezzanine bonds, subordinates backed by high LTV loans slightly outperformed those backed by low LTV loans. Average nominal and option adjusted spreads on high LTV subs tightened by 30 bp on average, representing a 7% tightening over the quarter while spreads on subordinates backed by low LTV loans tightened 20 bp or 6% since the beginning of April. Net of bonds issued as first loss securities, where a loss coverage multiple would not apply, multiples on subordinate bonds broadly increased by 28% with multiples on low LTV loans expanding more meaningfully than those backed by high LTV loans at 37% and 21% respectively.

Screening for relative value

Given the recent tightening across all CRT cohorts, relative value looks likely to show up in different cohorts of CRT that have lagged the broader cohort level tightening and offer attractive OAS and loss coverage multiples. Looking first at mezzanine bonds backed by low LTV loans, certain seasoned 2016 vintage low LTV mezzanine bonds like STACR 2016-DNA1 M3 and CAS 2016-C03 1M2 may still offer attractive relative value. While the broader low LTV mezzanine cohort has seen OAS tighten by 21% and loss coverage multiples expand by 40%, the STACR bond has only experienced and 11% spread tightening while its loss coverage has increased by 69%. Using the same framework for mezzanine bonds backed by high LTV loans suggests that earlier vintage bonds may be similarly undervalued. One example of this is STACR 2015-HQA2 M3. While the cohort on average has seen a 15% tightening in OAS and a 28% increase in loss coverage, the bond has only seen a 7% tightening in its OAS while its loss coverage has increased by 50% over the quarter.

Turning to subordinate cash flows backed by low LTV loans where at the cohort level, spreads have tightened by 6% on average and loss coverage has improved by 37%, bonds in the 2016 vintage stand out again. For example, CAS 2016-C03 1B has experienced a 3% widening in its OAS despite a better than cohort improvement in loss coverage as its loss coverage multiple has improved by 67% over the quarter. In subordinates backed by high LTV loans, 2019 vintage STACR HQA series B2s may offer the most attractive relative value. STACR 2019-HQA1 B2 has experienced only a 1% change in its OAS despite a better than cohort level improvement in loss coverage. Admittedly, 2019 vintage high LTV deals by and large still maintain outsized populations of delinquent loans and lagging performance may be primarily driven by greater risk of default or modification related losses in these pools.

Checking in on the CRT mock draft

In April, Amherst Pierpont published the inaugural CRT Mock Draft providing six rounds of picks that based on a bond’s mix of tangible and intangible metrics appeared poised to outperform the broader cohort. Similar to any immediate analysis of a team’s draft it’s likely too soon to call the prospects outright winners or losers but to date most of the prospects have outperformed their respective cohorts. The timing of the mock draft roughly aligns with the beginning of the quarter but not perfectly so some of the performance of each individual bond may have occurred prior to the draft. With that said it appears that over the course of three months, the bonds selected have outperformed their respective cohorts, in some cases materially so.

  • Round 1: STACR 2020-DNA5 B2 – The rationale behind the first-round pick was that higher premium, post COVID B2s could offer significant upside given expected strong credit performance and a slowdown in speeds as a result of a steep forward curve coupled with low WAC collateral. Last month the deal paid at roughly 26 CPR, a slowdown of roughly 20 CPR versus its March speed. Using a low LTV subordinate cohort as our benchmark, the bond has significantly outperformed the benchmark as both nominal and option-adjusted spreads on the bond have tightened by 20% over the quarter while benchmark spreads only tightening by 6%.
  • Round 2: CAS 2019 -R04 2B1 – This bond garnered a second-round selection based on the belief that higher WAC, deep in-the-money should continue to prepay fast, allowing the bond to de-lever and roll down the credit curve. Since the beginning of the quarter, the bond has tightened by 50 OAS representing a 10% tightening in spread versus a high LTV subordinate benchmark of 6% and continues to exhibit elevated prepayment rates, prepaying at over 50 CPR last month.
  • Round 3: CAS 2016-C01 2M2 – The third-round choice was a mezzanine bond that fit well into portfolios that require an investment grate rating or high NAIC designation. Over the quarter it outperformed its high LTV mezzanine benchmark as its nominal and option adjusted spread tightened by 22% versus 15% for the cohort while experiencing nearly a 20% greater increase in its loss coverage than the broader cohort.
  • Round 4: STACR 2018-HQA2 B2 – The fourth-round choice has modestly underperformed its cohort as it is a high stated margin bond that is still experiencing elevated prepayment rates, limiting price upside and OAS tightening. As a result the bonds OAS has tightened by 4% versus cohort level tightening of 7% and given the recent flattening of the curve may still be subject to fast prepayments going forward.
  • Round 5: STACR 2020-HQA5 B1 – The fifth-round choice also bested its cohort level benchmark as nominal and option adjusted spreads have tightened on the bond by 11% versus a cohort level benchmark of 7% as post-COVID subordinates have experienced broad based spread tightening over the past quarter.

Round 6: STACR 2015-DN1 B – The final round selection was a fixed-severity first loss bond with potential upside to curing of the delinquency pipeline. In April the reference pool had 3.96% of loans that were more than 60 days past due and an additional 1.10% of loans that were more than 30 days delinquent. As of the June remittance, the delinquency pipeline has not cured materially as the population of current loans still sits at roughly 95.5% of the reference balance.

Chris Helwig
chelwig@apsec.com
chelwig

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