Aurum Wealth Management Blog

federal reserve

Not a Fed Note

There will be enough coverage of the Federal Open Market Committee meeting so we will avoid adding another log to the fire.  But rather than be a total contrarian and write on a financial planning or behavioral finance topic, we will talk about an asset class that also has a general consensus view among investors.

Non-agency mortgage backed securities (also known as private label, from say a Wells Fargo, and distinctly not an agency such as Fannie Mae), were at the center of housing bubble and subsequent 2007-08 financial crisis.  It really is no wonder how it happened.  Credit was extended to unworthy borrowers, loans were taken out on inflated home prices, and when the well ran dry we had the largest housing bust in history.

With debt truly being a four-letter word, low real income gains, and tighter credit standards, homeownership rates in the U.S. now stand at a 48-year low at 63.5%, compared to the peak of 69.5%.  During the bust, default rates spiked in mortgages with lower credit ratings.  This led to large price declines across private label mortgage backed securities.

The appetite for issuers and end demand of investors ran dry, bringing the market to a halt.  From 2001 to 2014, issuance fell 84%.  This compares to decent growth across other securitized credit such as auto loans and commercial mortgages, though credit cards and student loan issuance declined somewhat.  Because more mortgages were paid off (through refinancing or selling homes) than were issued, the private label MBS market shrunk rapidly the last several years.

So we have an asset class with mid-single digit yields, low interest rate sensitivity (due to the floating nature of payments), trading below par, low supply due to issuance, and low demand from investors due to high complexity and the recent feeling of being burned in the last cycle.  The fundamentals for the underlying asset, and housing continues improvement. Household formation is growing rapidly, affordability is below the long-run average, there is a low supply of single family housing, and credit availability is at a 5-year high.

It adds up to a decent opportunity in a low yield environment with the Fed interest rate hiking cycle on the horizon (the only mention of the Fed! I promise.).

Source: Morgan Stanley Research, Bloomberg

Year-to-date returns were strong across the credit stack through August.  Our fixed income managers continue to maintain core allocations to the private label (non-agency) residential mortgage-backed securities space and we continue to find compelling evidence for the asset class.

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This material is based on public information as of the specified date, and may be stale thereafter. Aurum Wealth Management Group and/or Aurum Advisory Services has no obligation to provide updated information on the securities or information mentioned herein. Actual events may differ from those assumed and changes to any assumptions may have a material impact on any projections or estimates.

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