FLASH UPDATE: Normalization of Non-Agency RMBS

It all starts at the ground level – or more specifically at the underlying asset.  The housing crash and recovery led to write-downs and then opportunities for investors in Non AGY MBS.  Now, as this article demonstrates, the opportunity in housing is normalizing, and so too will the returns of instruments tied to the recovery (notwithstanding a handful of niche sectors).  On the plus side, stabilization of the housing market and shifting paradigms in homeownership are opening the door for an increase in loan origination and new asset classes like single-family rental securitizations.  We are moving into a new era for residential mortgage credit investing where opportunism, research, and breadth of experience will preside over credit beta.

Home Investment Market Shifting with Fewer Foreclosures

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: How Will the Newbies React to the Coming Change in Interest Rates?

People tend to have short memories and that can become problematic when it comes to investing.  Having no recollection at all can be even worse.  Wall Street’s newcomers have benefited from an extremely accommodative introduction to their careers and the resulting false bravado will likely lead them to underestimate the pitfalls that arise in during tightening cycles.  Investors should choose carefully when seeking advice and allocating their capital.  If we ignore history we are doomed to repeat it.

See the below link for an interesting Bloomberg article and clip:

What Will Happen to a Generation of Wall Street Traders Who Have Never Seen a Rate Hike?

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: TRV Mid-Month Commentary - Rates on the Move!

TRV Mid-Month Commentary | May 2015

Policy Update:

Before we provide an update on our markets, we would like to outline an important FHFA proposal that, if passed, will have significant impact on the markets in which we trade. On May 15, the FHFA released an update on the structure of the Single Security in accordance with the goals set out in the 2014 Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac. The main goals of the Single Security are to build a Common Securitization Platform that adds market liquidity and reduces or eliminates taxpayer costs of Freddie Mac securitizations.

Freddie Mac securities traditionally trade at a discount to comparable Fannie Mae due to reduced liquidity. If the proposal is passed, we expect Fannie Mae and Freddie Mac securities to trade close to parity during and after the transition. Overall, we believe the proposal will increase market liquidity and reduce taxpayer costs as mentioned by the FHFA.

Comment:

Despite the disappointing revision to March’s Change in Nonfarm Payrolls, Treasuries sold off dramatically in the first half of the month. 10yr yields ended 26 bps higher and the curve steepened 12 bps 5s/10s. We expect IOs to perform well in a higher and steeper yield curve environment. Likewise, we would expect CMBS and residential credit to generally increase in valuation as buyers seek yield.

One impact on valuations would be an increase in delivered and implied volatility. Over the past two weeks, swaption volatility increased 13 bps (1 month into 10 year). Since our portfolio is tactical in nature, we stand to benefit from dramatic market changes that lead to mispriced assets. Pass-throughs may present such an opportunity as prices dramatically lagged those of Treasuries. We thus see an opportunity to be long the mortgage basis given recent underperformance and the likelihood that Treasury yields will remain range bound until further direction from the Fed. Decreased prepayment risk should provide further tailwind to the pass-through market and provide opportunity for spread compression.

In April, 30yr and 15yr conventional mortgage speeds declined beyond the street’s expectations. The key surprise for many investors was a larger than expected slowdown in new vintage collateral. This may signify that the street prepayment models are mis-calibrated to refi-sensitivity and, in our view, the market is under-valuing many prepay-sensitive bonds. As such, we have seen IO valuations rally and we continue to also look at other asset classes for opportunity.

                                                                                                         

Spread products, such as CMBS and residential credit, may be such asset classes with foreseeable spread compression as higher rates often indicate an improving economy. Commercial property fundamentals remain strong and we expect the trend to continue. In residential credit, we see limited upside to legacy positions, except in specific niche sectors. But at the same time we do not anticipate major spread widening in the near term as housing fundamentals and market technicals remain strong and supportive of the sector. Of note, we see value in Credit Risk Transfer (CRT) deals and point to wider spreads vs legacy RMBS particularly during market pull-backs.

While valuations on securities that stand to benefit from slower prepayments continue to grind higher, we are positioning ourselves to be opportunistic. We expect rates to end May higher as the market anticipates the pending Fed activity. However, we foresee near-term volatility remaining elevated given the uncertain nature of the forward rate path. As we mentioned, our strategy should benefit from such volatility as it will create openings for our tactical approach.

Regards,

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: Jeffrey Gundlach's History Lesson on the Fed & High Yield Bonds - Warning!

Jeffrey Gundlach, Warren Buffett, Bill Ackman & Carl Icahn all can agree on one thing...They don't want to own any high yield bonds!  The short high yield strategy has been getting some great press lately, as the warning signs flash brighter and brighter.  

“The risk is there could be a run on the bond funds, causing further downward price movement. A lot of investors don’t like Treasurys. They’ve been searching for yield and throwing caution to the wind,” said Jeffrey Gundlach.

“If I had an easy way, and a non-risk way, of shorting a whole lot of 20- or 30-year bonds, I’d do it,” Warren Buffett said Monday on CNBC. “...But I think that bonds are very overvalued, I’ll put it that way.”

“I don’t like fixed income as a category, particularly at today’s interest rates,” said Bill Ackman in a Bloomberg Television interview this week.

“What’s even more dangerous than the actual stock market is the high-yield market,” said Carl Icahn on this weekend's episode of the show “Wall Street Week".  Money keeps pouring into high-yield bond funds, even though that market is “ridiculously high,” Icahn said. “When they start coming down, there is going to be a great run to the exits,” he added. 

Gundlach, Buffet, Ackman & Icahn have joined Bill Gross, Stanley Drunkenmiller, George Soros, Ray Dalio & Jeremy Grantham in cautioning against overpriced and bubbly financial markets.  The bottom line is easy to see, some of the greatest investors of all-time are warning everyone...Don't own any high yield bonds!  Tradex is positioned to take advantage of this opportunity.  Click on the below link to watch Jeffrey Gundlach's recent high yield warning.  #ShortHY

Jeffrey Gundlach's High Yield Bond Warning

Richard Travia

Director of Research

FLASH UPDATE: TRV Mid-Month Commentary - When is that Rate Hike Coming?

TRV Mid-Month Commentary | April 2015

Comment:

Yields have fallen month to date with the front end of the curve leading the rally. The price action left the 10yr at 1.89% and the curve 2 bp steeper 5s/10s. The litany of poor economic releases is to blame for the rally, with Non-Farm Payrolls (NFP) being the most damaging to investors’ sentiment. Change in NFP came in at 126k versus 245k consensus, but we remind investors that the economy needs job creation at 80-90k net per month to maintain the unemployment rate. Retail sales also disappointed having come in at +0.4% versus +0.7% expectations.

While employment changes receive headline attention, the FOMC notes that energy prices, the strength of the dollar, and other factors warrant consideration prior to commencing rate normalization. The slope of the yield curve implies that investors have changed their estimated liftoff date from June to September. Although recent economic releases have been poor, some have chalked them up to be noise in an otherwise healthy economy.

April’s MBS prepayment print was much anticipated due to January’s dramatic drop in rates and the 50 bp Mortgage Insurance Premium (MIP) cut for GNMA collateral. Higher purchase seasonals and a greater March day-count further contributed to speeds. Overall, 30yr collateral increased 23% with new vintage cuspy coupons, such as 3.5s and 4.0s of 2015, notably higher having increased 39% and 119%, respectively. GNMA-I and GNMA-II voluntary prepayment speeds increased 31% and 23% respectively, largely on the 50bp MIP reduction that was announced in January.

Related to speeds, the FHFA announced that it will eliminate the adverse market charge instated in 2008 and will replace this revenue by increasing guarantee fees. For high LTV and low FICO borrowers, the LLPA charges will drop 25 bps. Since the option to refi is less callable for this subset of borrowers, we expect the overall market impact of the policy change to be minimal.

In the mortgage market, the dramatic decrease in vol and the steeper yield curve pushed MBS noticeably tighter with 3.5s outperforming the Treasury curve by 11 ticks. Benchmark IOs did not fare as well as lower rates reignite prepayment fears. IOS 4s widened between 30 and 45 bps the last two weeks while 4.5s widened closer to 60 bps. We view this temporary widening an opportunity as carry remains attractive and the fastest speed prints are likely behind us.

Noteworthy:

We see upcoming opportunities in mortgage credit markets. First, FNMA released details regarding the sale of non-performing loans to private investors. Such new deals may provide yield that investors desperately desire at discounted prices. Secondly, HPA came in +5.7% year-over-year providing relief to underwater borrowers. As curing continues, voluntary prepayments may provide future upside as most RMBS are priced below par.  Lastly, there is approximately $5.6 bln of current pay, never modified 10yr IO loans that are set to begin amortizing. As such, Alt-A deals with this collateral may provide considerable prepayment upside that we feel the market isn’t accurately pricing.

Regards,

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

FLASH UPDATE: TRV Weekly Commentary - Rate Normalization?

TRV Weekly Commentary

Week Ending 18 Feb 2015

Comment:

We saw quite a bit of market activity this week pre and post FOMC minutes. The rates market continues to focus on the tone of the minutes to infer when a normalization cycle will commence. Investors and the sell-side community generally anticipate a summer rate hike that has caused the yield curve to flatten over the past year with higher short-term rates and a strong global relative value story on the US 10yr. The minutes this week, however, reflected that FOMC participants are inclined toward “keeping the federal funds rate at its effective lower bound for a longer time.” The dovish tone sent 10yr yields about 8 bps lower before ending the week 6 bps higher at 2.08%. Despite the action in the 10yr, the true story in rates is the 9 bps of yield curve steepening which is beneficial to the carry component of MBS.[1]

With 10yr yields backing up 6 bps, MBS outperformed the benchmark 3 ticks while slightly underperforming the swap curve. We are relatively neutral on the basis given our bullish stance on vol due to European headlines, low inflationary prices and increased uncertainty as to the timing of a rate normalization policy. If the curve reverses this week’s movement, we would anticipate down in coupon swaps to perform well and for specs to outperform TBAs on reignited refi fears and increased desirability of call protection.

That said, the refi index fell 16% this week to a point that lies 27% below January’s peak. Much of the decline is attributable to the bear steepening of the curve we have seen as of late. In addition, savvy borrowers have likely taken advantage of January’s sharp decline in mortgage rates, which should cause a decreasing rate of refi applications. The decline in the refi index and the bear steepening yield curve provided tailwinds to IOs this week. Benchmark IO 4s were particularly penalized in January’s rate rally and so we have seen this sector outperform other IO sectors. Vendor OAS shows this sector has tightened between 5 and 38 bps.

Regards,

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global

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[1] A steeper yield curve implies higher mortgage rates in the future, thus reducing prepayment expectations. We ran a FN 3.5 TBA using a live swap curve at the current market price and obtained an OAS of -5 and a long-term CPR of 13. We then re-priced the same bond with a 50bp steepening scenario and calculated an OAS of -27 and a long-term CPR of 8 that coincides with a 50-80 bp higher MBS current coupon.

FLASH UPDATE: TRV Weekly Commentary - Rate Volatility Will Persist

TRV Weekly Commentary
Week Ending 11 Feb 2015

Comment:

The impressive US non-farm payroll headline defined the week’s risk-on tone and was the driving force behind the yield curve. January NFPs came in strong at 257 versus 228 consensus, but more noteworthy was the two-month payroll net revision of +147k. Yields soared with the 10yr ending the week 27 bps higher, equivalent to 78 ticks of price decline. Despite higher rates, vol remained stable.  We suspect this will be short-lived, as US headlines will likely take a back seat to geo-political concerns.

With the refi index printing 274 points lower, prepayment fears beyond the April print have subsided, leaving interest-only paper tighter. Benchmark FN4 IOs of 13, for example, narrowed 120 basis points. This is equivalent to an outperformance of 5.4%, erasing half of the January widening. To no surprise, up-in-coupon trades also performed extremely well. FN 4.5s outpaced the stack, having tightened 12 ticks versus the curve. Additionally, rolls strengthened into 48-hour day with FN 4.5s increasing 1.5 ticks. For now, the TBA market has been rate-directional. We would like to point out that convexity levels are much higher: investors need to be weary of both sharp sell-offs and rallies as convexity hedging may come into play. We are neutral on the basis for the time being given the asymmetrical risk.

This week, the market again viewed the world as riskless, as investors seemed to have forgotten about the global growth glut, declining energy prices and growing economic frictions within the Euro Zone. We note that we are one headline from a risk-off market, and even a partial reversal of this week’s rate movement could reignite refi concerns. Our view is that rate volatility will increase as we move closer to ground zero of the hiking cycle.

Regards,

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global