Hot property: US RMBS adapts to shine in world of higher rates

With mortgage originations in the US still historically low and the average 30 year mortgage interest rate not dipping below 6%, 2024 looked set to be tough for those charged with structuring RMBS deals.

Yet it proved a banner year. By November 15, RMBS issuance had reached $115.8bn, according to Finsight — nearly double 2023’s full-year volumes of $62.4bn.

Robert Durden, co-head of mortgage origination at Atlas SP, describes 2024 as a “comeback year” for RMBS, with the market having weathered the 2023 litmus test of rate rises and wider credit spreads well.

“There has been broader investor involvement and we saw it ebb and flow into various sectors depending on relative value considerations,” says Durden. “We saw investors consistently paying more attention to other sectors in RMBS, like second liens and residential transition loans.”

Indeed, 2024’s surge in issuance volumes was particularly notable for its variety. As originators sought to navigate around the so-called “lock-in effect” of homeowners being unwilling to sell that continues to suppress traditional mortgage volumes, so the RMBS market responded.

Issuance backed by second lien loans and home equity lines of credit (Heloc) climbed from $4bn in 2023, which was already a record, to $12bn in the year to November 19, according to Bank of America. RMBS secured by residential transition loans (RTL), which had grown to around $2bn in 2023, ballooned to $6bn by November 19. BofA predicts it will reach $9bn by year end and grow to $10bn in 2025.

One of the reasons for the growth of these alternative asset classes is that they have developed quickly to reach the broadest possible set of investors.

“We have seen an increasing focus this year on getting specific asset classes into rated securitizations — whether that is scratch and dent deals, Helocs, HEI [home equity investment] or RTLs,” says Ryan Singer, managing director and principal at Balbec Capital.

Home equity products should continue to have a “steady tailwind”, Durden says, in large part because of “elevated rates, the lock-in effect and sizeable home equity”.

Second lien and Heloc RMBS issuance could reach $20bn in 2025, according to BofA forecasts, which would be five times 2023 volumes.

Yet as well as pushing home equity products, originators have also sought to tap borrowers who need a mortgage regardless of the rate environment — and those who do not meet typical borrowing requirements. In this environment, non-qualified mortgage (non-QM) RMBS has blossomed into the number one driver of issuance volumes and is set to post record annual issuance volumes of around $40bn.

Mike Fania, deputy chief investment officer and head of residential credit at Annaly Capital Management, describes 2024 as “the year of the non-QM market as well as of the second lien and residential transition loan markets”. And he says the sector could be ripe for even further growth.

“Currently, non-QM and DSCR [debt service coverage ratio] originations only make up about 5% of all originations but could go to around 10% over the next few years,” says Fania.

For his part, Raman Guglani, RMBS portfolio manager at Franklin Templeton Fixed Income, believes total whole loan non-QM originations could hit the $100bn mark in 2025 and says non-QM RMBS issuance could be $50bn-$55bn.

With broader participation, greater comfort with transactions and better markets, next up could be larger deal sizes.

“We would like to see $1bn deals, like pre-GFC,” says Fania. “We have been trying to lead the way with $500m-$700m sized non-QM deals, and those have gone well.

“It comes down to the market getting comfortable, banks providing liquidity, and making sure the pricing is there.”

Behind the success of all these growing asset classes is the insurance sector, which is looking to deploy huge amounts of capital. Guglani says that these investors dominated the market this year with their bid for non-QM collateral.

“The insurance demand for whole loans in the DSCR, second lien and Heloc markets remains strong,” says Fania. He estimates insurance companies purchase 30%-35% of non-QM loans. This has caught the eye of originators.

“We are also focused on what insurance companies will do from a demand standpoint and how many new loans we can buy if the demand by insurance companies for whole loans persists,” says Singer at Balbec.

Preston Blankenship, head of ABS and RMBS syndicate at Deutsche Bank, notes that insurance and private equity-type accounts “have a lot of cash to deploy”.

One of the key factors bolstering RMBS is that housing has continued to fare well.

Paul Nikodem, head of US fixed income research at Nomura, says that, arguably, RMBS is enjoying the strongest tailwinds across all securitized products.

“The mortgage credit story hasn’t changed much,” he says. “Investors continue to price in housing-related strength”.

Nomura expects home price appreciation to slow to 2% “due to weaker buyer demand”, although it describes the housing market as “strong”.

Much will depend on the policies of the next government, with Donald Trump’s victory in the November presidential election proving positive for US risk assets but also raising investors’ concerns about inflationary policies such as trade tariffs.

“Home price appreciation could be higher if tariffs are more limited in scope, as lower inflation in that scenario should ultimately lead to a lower mortgage rate,” says Nikodem. “The focus is on tariffs, inflation risk and navigating a higher rate world”.

Blankenship believes investors overall are “sanguine about market risk and the direction of rates” and says that challenges will be “technical, not fundamental”.

Volatility affecting RMBS deals could emerge from inflation data, the various noises from the US Federal Reserve, and instability in benchmark rates making it hard to evaluate pricing. However, the RMBS market has the advantage of having already recently weathered a rate increase cycle.

Most RMBS issuance this year has had “on-target” coupons, as rates held steady, rather than the “underwater” coupons seen in deals brought to market in the wake of rising rates in 2022 and 2023, says Blankenship.

Although market participants expect that to continue, if rates do not fall as expected, it would eventually take its toll.

“If we persist at these levels of elevated mortgage rates, we could see originations and issuance slow down, but there is a lag effect at play,” says Peter Sack, co-head of mortgage origination at Atlas SP.

On the demand side too, confidence in rates has played a huge role in most offerings being many times oversubscribed.

“This supported the market and allowed spreads to compress as investors sought to take big allocations to get ahead of any further Fed rate reductions,” says Blankenship. “Investors are still looking to put cash to work despite any macro risk and the uncertainty around the new administration.

“I have been impressed by how demand has been able to keep pace with the amount of supply. I wouldn’t say spreads are moving materially tighter, but we are seeing extremely strong execution on the back of this strong demand and a general grind tighter in spreads.”

As investors grew more bullish on the fight against inflation, they were able to shift from just looking for a carry trade to seeking higher total returns thanks to an appreciation in bond prices.

“Investors have tried to lock in duration on longer bonds, while keeping in mind pre-pays,” says Singer at Balbec.

Some of the incremental demand has come from certain accounts returning to the asset class as performance data grows and investor comfort builds, says Fania at Annaly, which issued 20 transactions totaling $9.8bn, according to Finsight — almost double its biggest previous year by volume.

“This year we saw the number of investors grow and we issued more transactions,” he says.

As demand has grown, so the credit curve has flattened.

“We have seen strong demand in the mezz and subordinated parts of the capital stack,” says Guglani at Franklin Templeton. “People feel more comfortable with mortgage credit.”

Although pricing can be more unpredictable further down the stack as housing and economic data comes in, Sack at Atlas sees “more of a lean towards bonds grinding tighter and less risk of widening at the top”.

This greater comfort with the mortgage credit has also allowed issuers to modify their offerings.

“We have executed some [mezzanine] classes in some of our unrated offerings to aim to provide investors with a higher yielding product and they have been receptive to them,” says Singer.

He highlights money market inflows and Fania says there is around $6.5tr sitting in these funds.

“A lot of this money we think is waiting for short term rates to decline and a good portion could find its way into RMBS,” he says.

It all contributes to a sense of optimism for the year ahead: “2024 has been a busy year and we expect there is more to come in 2025,” says Singer.