Hedge funds, money management firms and alternative investment managers are doing their best to revive the non-agency residential mortgage-backed securitization market, which has been almost dead since the financial crisis.
As a result, investment in non-agency RMBS across asset classes is ticking up.
Fixed-income and other managers have loved the pre-crisis bonds for a number of years now because they can see which mortgages are performing and most of the foreclosures that are likely to happen have already occurred.
The new trend in non-agency RMBS is focused on managers trying to restart the market by issuing bonds based on new mortgages. The majority of the loans in many of the new non-agency RMBS mortgage pools are subprime.
The demand is there — from alternative investment managers, insurance companies, money managers and real estate investment trusts vying to buy the securities — but the supply isn't enough, industry executives say.
The non-agency RMBS market is really multiple markets that appeal to different buyers and sellers. In the same RMBS deal, one type of buyer — including fixed-income managers — will invest in the senior, most protected portion of the security. Another type of buyer — generally hedge funds and real estate investment trusts that can invest in high yield — will invest in the riskier junior tranches, which take losses earlier.
In the non-agency RMBS market, the prime jumbo sector was the first to come limping back to life, with banks being the main issuers. It is still a much smaller market than before 2008, because the lower housing prices relative to historical norms mean more loans qualify for agency mortgages. RMBS that hold big slugs of non-qualified mortgages are just lately being issued, with hedge funds and other alternative investment managers as big issuers.
The non-agency RMBS market is nowhere near the behemoth it was before the financial crisis, said Harrison Choi, a Los Angeles-based managing director and co-head of securitized products for TCW Group Inc.
Non-agency accounted for 56% of all RMBS in 2006, representing $1.17 trillion, according to the National Association of Insurance Commissioners. In 2015, non-agency RMBS sat at $75.9 billion, or 5.4% of the market.
Before the crisis, the non-agency market was dominated by finance companies and subprime lenders, said Mark Palim, Washington-based vice president, deputy chief economist at Fannie Mae.
“A lot of those withered up and the market switched to Fannie, Freddie, FHA and banks that hold the loans in their portfolios,” Mr. Palim said. “We are not surprised people are doing loans they don't think they can sell to us.”
But it is a hard sell, he said: “Large investors felt burned and are highly skeptical of something that doesn't meet agency standards.”
Still, a number of alternative investment firms, including Lone Star Funds, Beach Point Capital Management LP, Angel Oak Capital Advisors LLC and Varde Partners Inc., or subsidiary firms, have launched multiple issues of these non-agency bonds, with bundles of mortgages of borrowers who do not qualify for loans from the agency lenders or banks.
“These are healthy signs that the non-agency market is trying to find its way and come back,” said Mr. Choi. TCW's fixed-income strategies invest in non-agency securities, but Mr. Choi declined to say how much is invested.
“That said, it's in the very, very early stages,” Mr. Choi said. “We are very far away from where we were before the financial crisis.”
There is “decent demand” for the new RMBS issues, said Vesta Marks, portfolio manager at alternative income and opportunistic credit firm Palmer Square Capital Management LLC, Mission Woods, Kan. “The demand is being driven by the fundamentals in the housing market,” Mr. Marks said, noting that foreclosures are coming down and home sales remain strong.
Many RMBS carry floating-rate coupons, Mr. Marks said. “So, at the current level of interest rates and with the concern of interest rates rising, the floating-rate nature of the securities are attractive,” he said.