New Residential Mortgage redit Update · 2018. 10. 9. · One area which has undergone dramatic growth is the new origination non-qualified mortgage (non-QM) loan market. Securitization

Residential Mortgage Credit Update

October 2018

333 S. Grand Ave., 18th Floor || Los Angeles, CA 90071 || (213) 633-8200

Ken K. Shinoda, CFA Portfolio Manager, Mortgage-Backed Securities

Steven R. Wald Trader, Mortgage-Backed Securities

Kubat Akmatov, CFA, FRM Trader, Mortgage-Backed Securities

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RMBS Update September 2018

Residential mortgage credit, in both securitized and whole loan form, continues to be well bid through the first nine months of 2018. Strong demand from investors coupled with limited supply kept legacy and new issue non-Agency residential mortgage-backed securities (RMBS) spreads at tight levels, despite higher interest rates across the yield curve and recent global equity volatility surrounding trade wars. We expect RMBS supply/demand technicals and healthy housing fundamentals to translate into continued outperformance for the sector on a risk adjusted basis.

Through mid-September, the legacy non-Agency RMBS universe stood at approximately $422.7 billion in outstanding balance, with current supply running off at an annual rate of 14-15%. On the new issue front, supply continues to be steady with total securitization issuance year to date of $55.7 billion, led by legacy re-performing loans (RPLs) and new origination prime jumbo loans at $24.0 and $17.0 billion, respectively. RPL issuance is the largest source of supply in 2018 and is on pace to be slightly lower than 2017 largely due to a flatter yield curve eroding securitization economics. Senior spreads for rated RPL deals hit their tights in the first quarter of 2018, but have since widened ~15-25 basis points (bps) primarily driven by concerns around extension risk (slower prepayments) due to higher interest rates.

Non-performing loan (NPL) securitization volumes stand at $8.4 billion to date, which is on pace to be substantially lower than the $22.8 billion issued in 2017, due to lower supply in the primary whole loan markets. NPL spreads have remained steady this year, with NPL senior bonds currently yielding 4.00% - 4.50%. We continue to favor senior tranches of legacy loan (NPL/RPL) securitizations given their relative short duration and attractive spreads.

One area which has undergone dramatic growth is the new origination non-qualified mortgage (non-QM) loan market. Securitization issuance for 2018 is $6.3 billion – well above last year’s $3 billion total. Over the past decade, almost 50% of mortgage origination volume was driven by refinancing activity in a low interest rate environment. With higher mortgage rates this year and excess industry capacity, we expect non-QM origination volume to increase as more mortgage originators pivot towards these “expanded credit” programs in order to blunt the impact of diminishing refinance volume. To date, non-QM collateral performance has remained strong with low delinquencies and nominal losses.

While supply in non-Agencies is still net negative given the amount of legacy non-Agency RMBS pay-downs, the new issue market continues to see steady volumes. This could result in supply being net positive in 2019 or 2020 for the first time since the financial crisis. To put things in perspective, both investment grade and high yield corporate bond issuance has more than doubled since 2007. Given residential mortgage credit securitization volumes have lagged other sectors of the bond market for almost a decade, we expect strong demand to persist despite higher issuance.

KEY TAKEAWAYS

The supply/demand technical of non-agency

MBS and fairly balanced housing

fundamentals support continued out-

performance of residential mortgage credit on

a risk adjusted basis.

We continue to favor senior tranches of

legacy loan (NPL/RPL) securitizations given

their relative short duration and attractive

spreads.

Inventory of existing homes remains near

all-time lows while household formations

continue to increase with pent-up demand

supporting home prices.

We expect the current pace of home price

appreciation to decelerate due to diminished

affordability owing to higher home prices and

borrowing costs, as well as the limitations on

mortgage interest and SALT deductibility

under new tax legislation.

Housing market performance is likely to be

more dispersed on a go forward basis based

on regional affordability with some

overheated markets and higher price tier

housing vulnerable to potential decline in

home prices.


Residential Mortgage Credit

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Recent negative headlines around a slowdown in US new home sales and affordability concerns suggest the U.S. housing market is starting to show signs of weakness. While noteworthy, these recent data prints, when viewed within the context of the broader housing metrics, point to a market that is shifting from strong to more balanced fundamentals. Supply of existing homes is still near all-time lows, household formations remain elevated, and pent-up demand from millennials should continue to support home prices on a national level. However, affordability needs to be closely monitored as rising interest rates continue to weaken purchasing power of prospective homebuyers.

Home prices nationally continue to increase as the S&P CoreLogic Case-Shiller Composite-20 City Home Price index reported a 5.92% YoY increase in July. This index is now at a new all-time high, and 59.4% higher than the lows in March 2012. While the annual growth rate has slowed over the past three months, home prices still remain on an upward trajectory. However, we do expect the current pace of national home price appreciation to decelerate due to diminished affordability owing to higher home prices, higher borrowing costs, as well as the limitations on mortgage interest and state and local tax (SALT) deductibility under new tax legislation.

Looking at various housing markets, we expect fragmented performance based on regional affordability. CoreLogic recently published a report that analyzed the four different price tiers in the market. As of August 2018, the lowest price tier increased 8.2% year over year, compared with 6.8% for the low- to middle-price tier, 5.8% for the middle- to moderate-price tier and 4.4% for the high-price tier. We remain constructive on the low and low-to-middle price tiers as we expect higher demand from first-time buyers, which along with the lack the of new construction in these price tiers, should be supportive of continued growth. However, we expect the higher-cost areas, such as the West Coast and Northeast, along with some overheated markets to underperform with a potential decline in home prices.

According to the Homebuyer Affordability Composite Index, national affordability has weakened but is at long term averages. Nevertheless, unlike the prior crisis where low affordability was accompanied by high existing inventory and ample new housing construction, we are currently experiencing a combination of low existing inventory coupled with low new housing construction as a percentage of total households. We believe these factors will largely offset the negative impact of diminished affordability, particularly in the lower price tiers of the housing market.

Household formations and homeownership trends remain positive, with annual owner formations outpacing renter formations for the sixth straight quarter. In addition, the second quarter of 2018 experienced the largest annual growth in household formation since the first quarter of 2015. We expect this trend to continue as millennials, who on average tend to form households later than prior generations, transition from renting to

Existing 1-Family Home Sales—Inventory (# for Sale) 6/30/1982 to 8/31/2018

Source: Bloomberg, DoubleLine Base Cap: January 2000 = 100

Source: Bloomberg, DoubleLine


90

110

130

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Case Shiller 20 City Index 1/31/2000 to 7/31/2018 Not Seasonally Adjusted

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New Privately Owned One Unit Housing Units Completed

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Housing Trends


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homeownership. Recent statistics confirm that people under the age of 35 are experiencing the sharpest increase in homeownership rates.

In conclusion, we think that housing fundamentals remain balanced driven by long-term demographic trends and supply/demand technicals. We expect the current pace of home price appreciation to decelerate with lessened affordability due to both higher home prices and increasing mortgage rates. Housing market performance is likely to be more dispersed on a go forward basis based on regional affordability.

100

120

140

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Housing Affordability Composite Index 3/31/1986 to 6/30/2018 Not Seasonally Adjusted



Tho

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United States Household Formations Index 6/30/2008 to 6/30/2018

Not Seasonally Adjusted, Net Yearly Change

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Ken K. Shinoda, CFA

Portfolio Manager, Mortgage-Backed Securities

Mr. Shinoda joined DoubleLine in 2009. He is a Portfolio Manager in the Mortgage-Backed Securities Group and a per-

manent member of the Structured Products Committee. Mr. Shinoda also participates in the Fixed Income Asset Alloca-

tion and Global Asset Allocation committees. He currently leads the Residential Mortgage-Backed Securities (RMBS)

group which specializes in investing in non-Agency mortgage-backed securities, residential whole loans and other mort-

gage related opportunities. Prior to DoubleLine, Mr. Shinoda was Vice President at TCW where he also worked in

portfolio management and trading from 2004-2009. Mr. Shinoda graduated from the University of Southern California

with a BS in Business Administration. He is a CFA charterholder.

Steven R. Wald

Trader, Mortgage-Backed Securities

Mr. Wald joined DoubleLine in 2009. He is part of the MBS trading team specializing in trading and analyzing mortgages,

mortgage credit securities, and residential whole loans. He began as an analyst in the Risk Group focused on structured

products. Prior to DoubleLine, he worked at TCW in the Mortgage Group since 2008. Mr. Wald graduated from the Uni-

versity of Southern California with a BS in Business Administration.

Kubat Akmatov, CFA, FRM

Trader, Mortgage-Backed Securities

Mr. Akmatov joined DoubleLine in March 2017. He is responsible for non-agency MBS and residential whole loan trading

and analytics. Prior to joining DoubleLine, he was Vice President in the Quantitative Risk Analytics team at City National

Bank. Prior to that, Mr. Akmatov spent four years at Private National Mortgage Acceptance Company, LLC (“PennyMac”)

serving in various financial analyst and valuation roles, most recently as Assistant Vice President of Valuations. He

received his BA in Economics and Finance from CSU Northridge. Mr. Akmatov is a CFA charter holder and GARP certified

Financial Risk Manager.

Authors


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Case Shiller 20 City Index — The S&P/Case-Shiller Composite of 20 Home Price Index is a value-weighted average of the 20 metro area indices. These metro areas include: Boston, Chicago, Denver, Las Vegas, Los Angeles, Miami, New York City, San Diego, San Francisco, Washington, DC, Atlanta, Charlotte, Cleveland, Dallas, Detroit, Minneapolis, Phoenix, Portland, Seattle and Tampa.

Existing One Family Home Sales—Inventory (# for Sale) - This index tracks the number of homes that are currently on the market.

New Privately Owned 1 Unit Housing Units Completed—Tracks the number of new housing units (or buildings) that have been completed during the reference period.

Housing Affordability Composite Index — Tracks the affordability of housing, typically based on a mix of median home prices, median income and mortgage rates. Value of 100 means that a family with the median income has exactly enough income to qualify for a mortgage on a median-priced home.

United States Household Formations—Tracks the number of residential units available in an economy.

Definitions


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New Residential Mortgage redit Update · 2018. 10. 9. · One area which has undergone dramatic growth is the new origination non-qualified mortgage (non-QM) loan market. Securitization