There has been significant investor and Street apathy toward the non-agency market, FTN Financial analysts said in a report released this afternoon.
This apathy can be attributed to the current European turmoil, uncertainties over the U.S. housing market, newly minted bank capital rules as well as yearend book-keeping considerations, they stated.
They said that even though the apathy is warranted, it creates good selective opportunities heading into yearend.
According to FTN analysts, leveraging the middle of the credit spectrum is not a wise investment strategy at this point. Investment grade investors should maintain their solid investment grade portfolios.
Meanwhile, hedge funds and money managers who have open mandates, analysts added, should be selectively involved in sub-investment grade space.
They stated that scenario analysis is key to strong performance. Although they said that anyone’s base case vector can be wrong, but the key is to minimize the chance of severely adverse outcomes versus mandated risk tolerances.
Amherst Securities Group (ASG) analysts also wrote about the relative value in non-agencies in a report released yesterday.
They pointed to the fact that in the last few weeks, there has been a recovery in many markets. However,non-agency RMBS has not been among these sectors.
Thus, this has resulted in non-agency RMBS looking as cheap to other products as it has at any point since 2008, according to ASG analysts.
Investors, they argued, are not purchasing because they are concerned about the following factors: mortgage technicals (dealer selling, selling caused by hedge fund redemptions and European selling); wide bid/ask spreads; the bonds' high price volatility; and weak correlation with other products.
While prices, analysts said, are probably going to remain volatile and can dip in the near-term, the medium-term outlook for this market is very favorable compared to other products. They suggested that this is an opportune time to start to scale into this market.
The recent market price action has created opportunities where the downside risk is fully priced in, analysts said. They saw many senior bonds where the risk adjusted return is 10%-11% in the base case, 4%-5% in stress scenarios, and 14%-15% in optimistic scenarios. These yields are fundamentally attractive to other sectors as high yield, where the nominal (non-risk adjusted) yields are 8%-9%, analysts stated in the report.
They also saw that the price spread between the cash high yield index and non-agency
RMBS is at or near its widest levels since they began keeping the data in 2008.
Prices are likely to remain volatile, they said, and could drop in the near term because of the factors such as weak mortgage technicals, perceived wide bid-offer spreads, high volatility versus benchmark indices, and a lack of correlation between mortgages and other products. But,
buyers are getting paid for this near-term uncertainty with a very favorable risk/return tradeoff.
"We can’t pick the best entry point for the non-agency RMBS sector, but we definitely
see this as an attractive entry point to selectively scale into purchases in this market," ASG analysts wrote. "We strongly believe mortgages are likely to outperform other products in the
medium-term."
