The mortgage-backed securities market might be heading to a prolonged period of wide spreads to Treasurys, which should continue to attract patient money managers willing to ride out this part of the cycle while feasting on the income.
Profiting from the current phase of the market will certainly involve more than parking and enjoying fattened yields in the months ahead, mortgage investment and research professionals said during a Mortgage Bank Association event on Tuesday. Expectations for a U.S. recession have not abated, and money managers will have to be savvy and stay vigilant about potential global risks.
Buyers of mortgage-backed securities—and agency MBS in particular—have changed significantly over time, Jeana Curro, a managing director and head of agency MBS research at Bank of America, told conference delegates during the session, "A look ahead at the expanding MBS supply." Byron L. Boston, chief executive officer and co-chief investment officer at Dynex Capital and Steven Abrahams, managing director and head of investment strategy at Santander U.S. Capital Markets, joined Curro at the panel where Mike Fratantoni, PhD, chief economist and senior vice president of research and industry technology at MBA served as moderator.
Money managers entered the MBS investment ecosystem as the Federal Reserve began to wind down its holdings, and more recently, banks began to shed certain holdings from their balance sheets.
Curro describes the money managers entering the MBS space as those who are passive investors and relative value investors. When the former receives inflows, they tend to allocate it to what is outstanding, with mortgages getting about 30%. The latter emerged and increased demand for mortgage-backed products when mortgages were cheap, she said.
While getting themselves comfortable with MBS returns, money managers have become an important source of demand, and those portfolios could even dominate the MBS market in about three to five years, Abrahams said. He added that at some point the MBS market will attract stronger interest from the real estate investment trust (REIT) sector, especially because rates make it easier to hold assets in a leveraged position.
To hear Boston tell it, money managers bring a stabilizing influence on the market.
"The system only works if there are long-term holders of the risk," Boston said, drawing on his experience with the industry going back to 1986. A 30-year, fixed mortgage is an unusual beast, globally, he said, adding that no one else would give another human being a 30-year loan with a prepayment option. "It's a great asset for our country."
Referring to 1998—when spreads between conforming, 30-year fixed rate mortgages and 10-year Treasurys were wide for a while—particularly where government policy drives returns, Boston said. The question circulating at Dynex Capital is 'at what prices will investors take up MBS assets', implying that they assets will eventually find a home on balance sheets. Buyers just need to have in-depth industry experience, especially to help them sense when global risks might introduce volatility to their buying endeavors.
Abrahams agreed, saying "they cannot be a closet indexer. It takes a lot of work, skill and conviction. Some managers have it, and some do not."
When comparing MBS' attractiveness to other credit assets, like corporate bonds, MBS could still look like a boon to the right asset manager, Curro said. Bank of America anticipates a mild recession in in Q3, which should spur demand for safe-haven assets.
"At the end of the day you have a government-guaranteed asset with 180-basis point spreads to Treasurys," Curro said, of agency single-family MBS. "It is very attractive."
