Finding Opportunity – and Security – in Securitized Assets
Text on screen: PIMCO
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Text on screen: Tina Adatia, Fixed Income Strategist
Tina Adatia: In our outlook, we talk about a preference for securitized or collateralized risk over unsecure, or more generic forms of corporate credit. And you've mentioned it upfront. So how are we thinking about that on a go forward basis?
Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer
Dan Ivascyn: Sure. So I use a non-government guaranteed mortgage as an example of sectors that caused so many problems during the last major crisis pre COVID, which was the global financial crisis. Post global financial crisis regulations, investor conservatism, rating agency conservatism have continued to create strong relative opportunities to source this type of risk. During periods where central banks had a lot of flexibility and where the economy was quite strong, you didn't necessarily need that extra protection, but given the world we live in today of extreme uncertainty, that extra protection can be sourced at a relatively low cost.
FULL PAGE GRAPHIC: TITLE – Corporate leverage has increased, while homeowners continue to de-lever; the line chart is titled: Collateralized vs. Corporate Risk; and plots the investment grade corporate credit leverage and homeowner leverage (non-agency MBS) from December 2008 – March 2021; it shows how corporate credit leverage has risen since 2014, while homeowner leverage has been falling during the same time period.
One example is just to take a look at a typical seasoned bond backed by non-agency collateral. What you'll see here is what the loan value ratio has done over the last several years. You're at a point today where, because of the big increase in housing valuations in the United States, but also in other areas of the world, you've taken an instrument that was once quite risky and have turned it into an investment that is very, very low risk because the average loan to value ratio, the average borrower equity across these pools can be as high as 50% or even greater. And I bring that up because there's certainly scenarios going forward where home prices stabilize, home prices go down. And again, this is just a proxy for the type of opportunities that could be sourced in the collateralized markets, in the securitized markets, which we, again, think makes a lot of sense given where we are within the cycle.
Tina Adatia: Thanks, Dan. Now moving on to another type of mortgage, agency mortgages, you mentioned them upfront, briefly what's your view on current valuations?
Dan Ivascyn: Well, they're looking attractive and there's some technical reasons for that and there's some fundamental reasons for that. One of the fundamental reasons for that goes back to the fact that interest rate volatility has been very, very high and as an agency mortgage investor, you'd prefer realized volatility to be on the low side.
FULL PAGE GRAPHIC: TITLE – Agency MBS: A decrease in demand from the Fed has raised mortgage rates and cheapened valuations. Two charts are shown; the title for the line chart at left is: Agency MBS Current Coupon Spreads; it shows that agency MBS spreads have widened almost 40 basis point since the Fed announced its intention to taper MBS purchases, back to its cheapest levels in two years; the bar chart at right is titled Conventional 30-Year Mortgage Rates; it shows that the 30-year mortgage rate was 3.17% in November 2021 when the Fed announced it would taper, and rose to 4.51% in March 2022; demonstrating that higher rates and wider spreads have caused mortgage rates to rise, likely lowering MBS supply, extending outstanding MBS and increasing yield potential.
But also the reason these instruments have become quite attractive is that the Fed has been very public in their intention to stop expanding their balance sheet through the purchases of agency mortgages, and perhaps in the future begin to reduce their exposure to this asset class. As always, markets anticipate these events, and you've seen significant widening in what is a very high quality, very liquid asset. So from an option-adjusted spread perspective, agency mortgages are looking attractive, and they're increasingly representing an attractive alternative to investment grade corporate risk or other segments of the market where you have a little bit more downgrade or default exposure.
So this is a sector where we've had significant holdings throughout the many decades of operating within these markets. We significantly reduced exposure as the Fed purchased a larger and larger percentage of the available float. And now given their intentions and the widening we've seen associated with some of the interest rate volatility of late, we've begun to add back to that sector of the opportunity set.
FULL PAGE GRAPHIC: TITLE – Agency MBS: Market composition creates opportunities for active management. Three bar charts are shown; the title for the first chart at left reads: Fed coupons had the richest valuations in November…; it shows how the spread for the agency MBS has increased; the second chart is titled: …the worst performance since tapering began…; it plots the total return of the agency MBS coupon from 11/3/2021-3/21/2022 and shows how performance has been challenged; the third chart at right is titled, …but continue to trade rich to non-Fed coupons, and shows that valuations remain high for agency MBS versus non-agency MBS. Text at the bottom of the charts reads: PIMCO continues to favor non-Fed focused coupons over Fed-focused coupons due to stronger valuations and less direct impact from the Fed.
And then also in terms of agency mortgages, in terms of what to target, perhaps not surprisingly the greatest weakness have been in the coupons that the Fed owns a lot of. So we still think it makes sense to leverage the team, take a very strong relative value approach to this sector and focus on opportunities where the Fed is not going to be selling, or at least not selling to the same degree. And a lot of these are in some of the higher coupon mortgages that also provide a little bit of cushion in certain instances from rising interest rates.
So this an attractive sector or a sector that's getting increasingly attractive from an overall return perspective. So attractive, we're not rushing into this space. We think you can be patient given concerning technicals, but again, a sector that PIMCO's liked for many years that looks again increasingly attractive.
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