Friday, November 13, 2015

FLASH UPDATE: What's Next in Credit

What’s Next in Credit

As credit sectors post lackluster returns and the residential mortgage backed securities (RMBS) market normalizes, many market participants are left to determine what lies ahead in mortgage credit investing.  With this blog, we share our perspective on potential opportunities in mortgage credit.

The heightened volatility experienced in Q3-2015 has affected several sectors in both equity and fixed-income investments. Although real estate fundamentals remain strong, non-agency RMBS have experienced spread widening alongside high yield and other risky assets – albeit less severe. While the flat to low-single-digit YTD returns posted by many mortgage credit hedge funds is favorable in comparison to those of other strategies, it highlights the notion that the double-digit returns witnessed the last five years are likely a thing of the past.  This shift in outlook has forced mortgage credit managers to pursue other potentially higher returning and riskier opportunities in mortgage credit. 

GSE Credit Risk Transfer (CRT) – Government-sponsored enterprises (GSEs), like Fannie Mae, Ginnie Mae and Freddie Mac, issue credit risk transfer (CRT) bonds to transfer a portion of credit risk on mortgages they guarantee to private investors. Such a transfer has the added benefit of diversifying credit risk among several investors, as opposed to concentrating it in the hands of GSEs. Spread widening and risk-off sentiment has pushed CRT spreads wider and the credit curve steeper.  At the same time, and the housing market continues to recover and the current low interest rate environment (i.e. low refinancing incentive for borrowers) remain supportive of fundamentals.  While there is value across the CRT space as a whole, we see the best risk/reward in the last cash flow (LCF) tranches. These classes have benefitted from strong housing fundamentals, resulting in homeowner balance sheet deleveraging due to strong prepayments and low defaults. With spreads 450 to 500 over swaps and spread durations of 7 to 8 years, we see this sector as having the potential to return 7 to 10 percent over the next year with strong carry and modest roll-down/spread tightening.  Issuance of CRT remains strong and by all accounts, the market is here to stay.

NPL/RPL – Non-performing loans (NPL) are those for which the debtor has not made his or her scheduled payments for at least 90 days. Consequently, the odds that these loans will be repaid in full is substantially reduced. Re-performing loans (RPLs) include NPLs where the debtor has started to make payments again. Overall, we view the market as vibrant given NPL and RPL residential whole loan issuance is starting to pick up, having reached over $20 billion thus far in 2015.  Yields are in the mid-single digits for relatively short average lives (2 to 3 years) and the bonds are often over-collateralized with strong underlying fundamentals.  With nearly $500 billion of collateral on GSE and financial institution balance sheets, we anticipate that loan sales will increase, as will subsequent securitizations.  Given the size of the pipeline, NPL/RPL remain a viable avenue for relatively steady mid-single digit returns for early adopters of the asset class.

Non-QM – The qualified mortgage (QM) rules opened the door for private investors to originate non-qualified mortgages, and these loans are now becoming a factor in the RMBS market.  Lenders are now seeking access to the securitization market, after reshaping the credit box to provide financing to creditworthy borrowers who were left out by the restrictive QM regulations, such as a debt-to-income ratios of 43% or less.   In September, Loan Star issued a $72 million transaction that stands as the first transaction secured primarily by non-QM loans.  The M1 tranche of that transaction has 6% of credit support and bears a 6.8% coupon. We expect more deals like this to price, offering potentially attractive investments in the credit space that can be exploited opportunistically.

CMBS - While there are pockets of opportunity in the legacy CMBS market, most securities are priced to optimistic scenarios.  Legacy CMBS bonds are also running off quickly as we navigate the 2015 – 2017 maturity wave.  Going forward, CMBS 2.0/3.0 will likely provide tactical and strategic opportunities to investors who are able to discern between the various loan pools. In-depth analysis is key to security selection for finding misunderstood pools that may not be priced to optimistic scenarios. CMBX tranches also provide investors with a liquid means of expressing positive or negative views in this sector.  At present, the BBB tranches look attractive after suffering during the global rout in August and September.  The 2.0 BBBs trade at spreads in the mid-300s over swaps with average lives of 6 to 7 years.  New issue 3.0 BBBs carry more spread duration with WALs of 9 to 10 years, but trade with spreads closer to 500bp over swaps.  At current levels, these securities yield 5 to 7% and offer good carry with fixed rate coupons.  As we pass through the 2015-2017 maturity wave, loan demand and issuance will begin to taper, resulting in technicals that are supportive to spreads. The present situation in CMBS may be prime for investment managers with cash holdings and deep knowledge of the space to opportunistically navigate the coming quarters.  

Single Family Rentals (SFR) – Containing features of both RMBS & CMBS, this component of the mortgage credit universe will remain relevant due to homeownership trends.  The overbuilding and rise in homeownership rate during the boom has led to the creation of a viable single-family rental asset class.  These securities currently offer an early adopter advantage and the sweet spot in the capital structure from a risk/return perspective is the single-A and BBB part of the stack.  Spreads range from 300 to 450 over swaps, depending on the shelf and tranche, assuming the 2yr base-case WAL that most deals carry. We see this as another opportunity for credit investors to capitalize on the sector’s evolution in the near to medium term.   

Summary

Mortgage credit sectors have undergone structural changes that make this space attractive to astute managers armed with cash holdings and the flexibility to strike opportunistically. Going forward, strong residential and commercial real estate fundamentals will likely support strong performance in GSE CRT, NPL/RPL, Non-QM and SFR securities. In addition, knowing how to re-underwrite CMBS deals will enable active managers to reap benefits from in-depth analysis of targeted loan pools.  Overall, the potential opportunities in mortgage credit make this investment space interesting for early adopters equipped with the expertise and cash on hand to take advantage of what’s next.


Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com 
203-863-1500

@Tradex_Global




Monday, November 2, 2015

Tradex Global Short-Biased High Yield Fund Ranked #1 Fixed Income - HY Fund in September by BarclayHedge

In September, the Tradex Global Short-Biased High Yield Fund was ranked for the 4th month in a row by BarclayHedge in their Top 10 Rankings, this time appearing as the #1 "Fixed Income - High Yield" Fund. Please see the below award:




This fund was ranked based on the data in BarclayHedge's Database of hedge fund managers