By the Numbers
The non-agency market in the wake of recent volatility
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 private-label MBS market has not been immune to the volatility in both equities and rates since the administration announced broad reciprocal tariffs on April 2. Despite the volatility, primary issuance and funding markets continued to function and secondary spreads initially gapped tighter in the wake of the 90-day pause on tariff implementation.
The non-agency market may continue to provide somewhat of a safe haven for investors as it offers assets with relatively short rate and spread duration, attractive carry and low beta to both MBS and investment grade corporate indices. Admittedly, this comes at the cost of selling liquidity, which may become increasingly valuable if volatility continues to persist. And persistently higher rates could put downward pressure on loan prices if they manifest in higher than expected, unhedged pull-through rates on pipelines of locked loans.
Spreads and issuance across the sector
Spreads are wider in the last week and the credit curve steeper across all new issue private-label exposures. ‘AAA’ classes of non-QM deals priced in the past week were between 175 and 180 bp, putting them roughly 40 bp wider than deals issued in March. In addition to widening at the top of the capital structure, the credit curve steepened, as the sell-off in equities pushed spreads on mezzanine and subordinate classes wider. Credit curve steepening translated to lower securitization advance rates as sponsors have chosen to retain more of the lower portion of the capital structure at issuance.
With ‘AAA’s pricing at 180 bp, it firmly puts these bonds at the widest they have been versus both mortgages and investment grade in the past two years. Current coupon MBS nominal spreads versus the interpolated, blended 5- and 10-year Treasury rates currently sit at 153 bp. A spread pick of 27 bp is the widest that basis has been since March 2023, when it sat at 21 bp, and 30 bp wider than the 2-year average spread of -3 bp between the two assets. Similarly, ‘AAA’s currently offer 113 bp more spread than the CDX IG index, in line with the widest it has been over the past two years (Exhibit 1).
Exhibit 1: ‘AAA’ non-QM at 2-year wides versus MBS and corporates
Source: Santander US Capital Markets, Bloomberg LP
Other sectors of the RMBS market have widened more than non-QM. ‘AAA’ classes of new issue RPL deals have cleared at 200 bp while super-senior bonds in closed-end second lien deals have cleared at 185 bp as investors likely view secondary liquidity in larger floats of non-QM seniors as better than the liquidity offered in other non-agency exposures.
The massive spike in rate volatility has pushed at least one sponsor to try to mitigate some of the negative convexity embedded in jumbo collateral by putting the loans in a non-QM structure. The structure will optimize coupons on senior bonds for par execution and potentially limit extension risk through the implementation of a 4-year date call and coupon step up. The deal, JPMMT 2025-3, will further carve the super-senior cash flow into front sequential and 4-year bullet last cash flow.
Thoughts on leverage and financing
Prior experience has taught the market that financing markets generally offer the first signs of potentially elevated levels of broader market stress. To date, financing markets are functioning normally for investors who use leverage to fund their non-agency exposures. Anecdotally, equity haircuts applied by dealers across the capital structure remain unchanged as financing desks likely see recent market conditions as more of a liquidity event than a credit one. And liquidity concerns appear somewhat muted as well. Financing spreads remain broadly unchanged, wider by anywhere from 0 bp to 5 bp across both investment and non-investment grade private-label exposures. The overwhelming majority of investors at the top of the capital structure, particularly in non-QM, are large investment managers who hold the assets unlevered in mutual funds. Conversely, holders of mezzanine and non-investment grade risk are generally securitization sponsors who lever their retained interests in the deals as well as hedge funds and REITs who participate down the capital structure. As a result, any potential liquidity gaps in non-agency financing will likely have an outsized effect on lower and non-rated bonds.
Anecdotal evidence suggests whole loan warehouse financing markets have not been materially affected by recent volatility either, with both spreads and haircuts broadly unchanged and no interruptions to loan fundings. While the rally in rates last week may have served to broadly obfuscate spread widening and the need to issue margin calls, this week’s sell off would have likely exposed any liquidity shortfalls in both CUSIP and whole loan financing arrangements.
Thoughts on downside risks
While the issuance and funding markets are functioning, albeit at wider clearing levels, it seems premature to claim that we are out of the woods and expect a near-term reversion to last month’s spreads. Structurally higher levels of rate volatility should continue to put pressure on nominal MBS spreads if both index and current coupon OAS continues to remain broadly unchanged. And if MBS spreads remain at current valuations or widen further, it will likely push non-agency spreads at the top of the capital structure wider in sympathy.
And while there has been little to no forced selling across CUSIPs or loans in the private-label sector, another risk is persistently higher interest rates could leave non-agency originators who have not sold forward their pipeline of locked loans unhedged in the face of higher-than-expected pull-through rates, which in turn can generate losses and reduce profitability. Non-QM originators broadly expect roughly two thirds of loans locked in their pipelines to pull through and fund, a push upward in rates can drive more borrowers to lock in yesterday’s rate and push pull through rates higher, leaving originators unhedged on the population of loans they did not anticipate to pull through and fund. Losses realized on the unhedged portion of their books could force certain originators, particularly thinly capitalized ones who rely on shorter-dated warehouse financing arrangements to sell loans below current market clearing levels which would, in turn, put downward pressure on prices across the broader loan trading market.
The private-label market may continue to prove to be somewhat of a safe haven for investors looking to insulate themselves from more volatile exposures or those with more fundamental risk to broad-based tariff implementation. With that said, outperformance may be judged on a relative basis more so than an absolute one as potential headwinds to spread tightening may continue to weigh on the sector.
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