Credit Suisse analysts highlighted in recent research the attractive investment opportunities found in fixed-rate IO MBS, specifically agency MBS.
"Cheap fundamental value on agency fixed-rate IO MBS and continued market sensitivity over their relative extension potential makes this product appealing to buy and hold investors," analysts wrote.
They added that the projected yields are higher on fixed-rate IO MBS compared to amortizing MBS across coupons, noting that yield differentials widen favorably for the IO MBS under a faster prepayment speed environment.
In terms of prepayments, historical prepayment speeds imply that realized prepayments on fixed-rate IO MBS are probably similar or faster compared to those on amortizing MBS. Analysts observed that the longer weighted average lives and durations on IOs come from the non-amortization feature. They believe the market pricing of the value of the amortizing cash flows is high since IO MBS are cheap.
Credit Suisse analysts also looked at the relative value of fixed-rate IO MBS compared to 10/1 hybrids. They said that current pricing levels show that agency 10/1 hybrids are priced at higher dollar prices versus fixed-rate IO pools. They noted that, assuming comparable prepayments, the higher dollar price on agency 10/1 hybrids could be attributed to the value of the reset, which results in an above market, premium coupon security. In other words, the value of the reset disappears significantly under faster speed assumptions.
The analysis also gives an indication of the price value on fixed-rate IO MBS cash flows under different prepayment scenarios. If prepayment speeds are 10% CPR or slower on these IO securities, then current pricing on them is close to fair value. However, analysts maintain that under faster speed assumptions, the relative value analysis used increasingly favors investing in fixed-rate IO MBS.
Faster historical prepayment observations on seasoned fixed-rate IO MBS are biased by above-trend home price appreciation rates, analysts noted. The higher loan concentration in areas (such as California and Florida) that have led the U.S. in home price appreciation rates have pushed prepays higher on fixed-rate IOs across rate incentive levels.
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