By the Numbers
Returns for private MBS in 2025 and positioning for the year ahead
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.
Managers who positioned at the top of the stack in non-QM and CRT mezzanine bonds delivered the best risk-adjusted returns to their investors last year. Looking ahead into 2026, those senior classes appear poised to outperform again, potentially driven by a combination of further Fed cuts and spread tightening from crossover corporate buyers. A continued decline in rate volatility could enhance returns for longer duration prime mezzanine and subordinate cash flows too.
Rounding out returns for 2025
Last year can likely be described as the top of the charts being populated by a combination of greatest hits and a best new artist. CRT mezzanine bonds have been somewhat of a stalwart in offering attractive risk-adjusted returns to structured product investors. While these bonds appear poised to continue to do so given the uncapped, floating-rate nature of the asset class, investors are required to trade relatively low absolute returns for low volatility of those returns as spreads on investment grade classes of those deals sit inside of 100 bp and absolute yields appear poised to decline if a newly minted Fed chair takes a more dovish stance on benchmark rates later this year.
Non-QM seniors, while somewhat of a relative newcomer have delivered attractive risk-adjusted returns given relatively low rate and spread duration as well as a low beta to both the broad MBS and investment grade corporate indices at 0.45 and 0.46 respectively over a 3-year observation. The newcomer of the group, senior classes of securitizations backed by second lien collateral posted a slightly worse Sharpe ratio than that of non-QM seniors.
While both non-QM and second lien seniors posted nearly identical average monthly returns of 0.52% and 0.53%, second liens returns were more volatile, largely driven by more meaningful post-Liberation Day spread widening. This dynamic looks likely to hold into future bouts of volatility as insurance capital will likely continue to provide somewhat of a backstop to potential spread widening in non-QM. Both non-QM and second lien seniors posted a substantially better Sharpe ration than the 1–3-year investment grade corporate index, which mimics the duration profile of the two RMBS exposures. Non-QM seniors bested the Sharpe of the short duration IG index by 60 bp. Second lien seniors beat the index risk-adjusted return by 25 bp (Exhibit 1).
Exhibit 1: Stacking up risk adjusted returns across RMBS exposures and major indices
Source: Santander US Capital, Intex Solutions, YieldBook, IDC
Looking to the year ahead
Looking into 2026, past may very well be prologue. Senior classes of both non-QM and second lien securitizations look likely to continue to deliver attractive risk-adjusted returns, potentially besting numbers posted last year. And enhanced returns can come from a couple potential sources. Short-end key rate exposures should do well if the Fed pivots to a more dovish stance under new leadership later this year. Short duration structured products may broadly benefit from spread tightening given heightened sponsorship from crossover corporate buyers looking to insulate themselves from what looks to be a substantial supply technical in corporate issuance which may grow that market by 9% to 10% next year.
Relative performance between the two cohorts will likely be primarily driven by prepayments and overall convexity. Non-QM seniors, particularly those backed exclusively or in large part by investor loans with prepayment penalties should both exhibit a longer ramp and slower terminal speeds than closed end second lien seniors.
Slowing HPA should improve convexity in both non-QM and second liens, albeit for different reasons. Less HPA should amplify the value of prepayment penalties in the non-QM cohort, as smaller amounts of trapped equity should weigh on investors’ inclination to pay larger penalties to release smaller amounts of equity. Slowing HPA will reduce combined LTV borrower deleveraging in second liens, which, in turn, will reduce SATO-based refinancing incentive. The spread between two-year and ten-year rates could weigh on relative performance too. A meaningful bear steepening of the yield curve could push non-QM issuer calls out-of-the-money, increasing potential extension risk, causing spreads to widen. Conversely, the deeper in-the-money call on second lien collateral looks to be far less susceptible to changes in the shape of the yield curve.
The continued, pronounced decline in rate volatility could help boost risk-adjusted returns on longer rate and spread duration cash flows into next year if these low levels of volatility continue to hold. Prime subordinates, particularly those backed by more positively convex agency eligible investor loans should outperform jumbo subs on both a risk and hedge adjusted basis as the markedly better convexity should translate to both more consistent returns and lower delta hedging costs. From a credit perspective, investors should skew exposures into either more seasoned, de-levered paper or post-2023 vintage bonds as the 2023 vintage continues to flash signs of relative underperformance in both prime and non-QM exposures.
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