By the Numbers
OAS and TBA-hedged returns point to seasoned GEO pools in MBS
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An analysis of the universe of specified pools priced on either side of par suggests that seasoned geography stories, particularly 100% Texas and Florida pools offer some of the most attractive relative value. Seasoned geography stories offer some of the widest OAS to TBA across specified stories. Across coupons, 5.0% pools backed exclusively by Texas or Florida loans offer the most attractive hedge-adjusted returns.
Stay up-in-coupon
With regards to overall positioning, it appears coupons on either side of par should continue to outperform discounts. Through April, deposit balances across bank balance sheets surged while MBS balances remained mostly flat. If banks do begin to invest against those deposit inflows, it should provide a tailwind for MBS spread tightening, particularly in coupons around par.
Continued money manager selling of MBS to either meet redemptions or rotate into other fixed income exposures may drive relative outperformance in higher coupons as well. Benchmarked managers would likely sell larger amounts of lower-coupon MBS as they make up a much larger portion of the index than 5.0% coupons and above. Within these coupons, investors should remain defensive and favor lower pay-up stories with less exposure to heightened pay-up volatility.
Screening for relative value based on pay-up and OAS
Given the overall bias towards lower pay-up stories, the relative value framework focuses on specified stories that offer the largest OAS spread to TBA at a relatively low pay-up. The screening criteria focuses solely on conventional 5.0% to 6.5% specified stories, looking at two coupons on either side of par. Based on this framework, seasoning coupled with certain geography stories, particularly 100% Texas in lower pay-up stories and 100% Florida in higher pay-ups, offers the most attractive relative value. Texas 5.5%s and 6.0%s from 2023 stand out as offering some of the widest OAS relative to their respective TBA cohorts, with relatively low pay-ups, roughly 10/32s for both coupons. The 6.0% cohort offers nearly a 30 bp pick in OAS versus TBA 6.0%, while the 5.5% offer a 23 bp pick up in OAS. Florida 5.5% and 6.0% pools from 2023 stand out as offering substantially wider OAS than their respective TBA cohorts, admittedly as substantially higher pay-ups than Texas pools, as pay-ups on Florida 5.5%s and 6.0%s are both just shy of one point. Conversely, certain New York and HLB specified stories appear rich based on this framework, particularly 250K max pools and seasoned New York pools across 5.0%s through 6.5%s.
Exhibit 1: Seasoning and geography appear to offer the best relative value
Note: Specified cohorts are limited to float >=$3 billion. W2D stories with a positive pay reflect seasoning pay-up in isolation. OAS pickup to TBA is calculated as the difference between the market value weighted average OAS of all pools within a given cohort relative to TBA.
Source: Santander US Capital, YieldBook
Texas and Florida 5.0% pools offer the best hedge-adjusted carry
After screening for pools that offer an attractive balance of pay-up and OAS, a representative pool for each cohort is hedged duration neutral with TBA to ascertain which stories offer the best hedge-adjusted returns. Hedge ratios are simply a function of the difference in duration between the specified story and TBA. TBA returns are multiplied by the hedge ratio to derive net hedge-adjusted returns.
Seasoned 5.0% Texas and Florida pools offer positive hedge-adjusted returns in the base case and across all modeled scenarios. The two stories offer comparable net returns across modeled scenarios with the Texas pool offering an incremental 10 bp of base case total return. The Florida pool selected, FN BV8903, offers a substantially greater OAS pick over TBA than the Texas pool albeit at roughly a half point higher pay-up. Hedge-adjusted returns on seasoned geography stories in 5.5%s are flat in the base case assuming a hedge ratio of slightly less than 1:1 and only offer positive returns into a pronounced rally or sell off. Hedge-adjusted returns in 6.0%s are modestly negative assuming a hedge ratio slightly greater than 1:1. Hedged returns on 6.5%s are the worst of all cohorts. At the cohort level, investor 6.5% offer the widest OAS relative to TBA but negative net returns assuming a TBA hedge ratio of 120%.
Exhibit 2: 5.0% specified stories offer the best hedge-adjusted total return
Source: Santander US Capital, YieldBook
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