The US Residential Mortgage Backed Securities (RMBS) market continues to look gloomy for 2023. This year, RMBS issuance volumes are expected to contract further from 2022 due to the impact of elevated rates, high inflation and the possibility of recession.
The main factors that will shape the RMBS market include a drastic reduction in origination volume and the abandonment of business by mortgage lenders, according to a report by DBRS morning star about industry prospects.
A series of lenders have gone out of business recently, and others have significantly reduced reduced operations, especially in the non-bank financial sector, according to the report, while noting that “industry capacity and the availability of capital, especially for non-conventional sectors, will create challenges.” .
In 2022, the Federal Reserve’s monetary policy to combat rising inflation caused lenders’ origination volume to plummet. This, in turn, led to a drop in the collateral that was available to back securitisations in the agency and non-agency secondary markets.
Interest rate stability provides the best environment for MBS performance, and inflation reduces investor demand for mortgage-backed bonds. Consequently, as demand falls, the prices of mortgage-backed securities fall, causing lenders to raise interest rates.
Against the backdrop of “declining house prices, high inflation, and potential volatility due to changing economic and geopolitical conditions,” RMBS transaction issuance volume will decline by approximately 40% to $61 billion in transfer of Prime, non-prime and credit risk (CRT) in 2023. That’s down from the expected total of $102 billion in 2022, according to a report from Kroll Bond Rating Agency.
“Increased market volatility has caused investors to demand higher spreads in RMBS sectors, leading to unfavorable pricing and deterring some market participants from entering the securitization portfolio,” KBRA said.
The private label MBS market will also face continued headwinds in 2023, continuing the damped impulse with the Federal Reserve’s MBS buy policy and volatile rates.
In particular, the largest government-sponsored companies (GSE) conforming loan limits will curb non-agency participation and securitized production with the recent change in loan ceilings, DBRS said in its report.
The Federal Housing Finance Agency (FHFA) raised the benchmark conforming loan limit for mortgage-backed mortgages fanny mae Y freddy mac to $726,000 in November, an increase of 12.21% compared to 2022. In designated high-cost areas, Fannie Mae and Freddie Mac are now buying $1 million-plus mortgages for single-unit properties amid rising prices of homes year after year.
Higher loan ceilings “theoretically will mean that more and more volume from the industry would qualify for conventional loans,” the report said.
“Esoteric RMBS,” which include reverse mortgages, deals backed by home equity lines of credit (HELOCs) and private label securitization (PLS) credit risk transfers (CRTs), may provide a silver lining in 2023, according to KBRA .
While such deals are not immune to economic conditions, KBRA expects the negative impacts in these sectors to be less than major, non-prime, and agency CRT deals.
“For example, with respect to HELOC-backed deals or secondary liens, we expect an increase in issuance as many borrowers hold a higher home equity position over the past several years,” KBRA noted.
HELOC originations grew from low levels for both bank and non-bank financial lenders newer to the market, with some home-backed RMBS deals coming to market, said Youriy Kouudinov, senior vice president of US RMBS. in DBRS Morningstar in a report. He expects newer nonbank financial HELOC products to see borrower acceptance with product features that help moderate credit risk.
“By 2023, HELOC originators may view securitization as an attractive exit strategy as there is still significant capital available from owners and lenders can price at current rates,” Kouudinov said.
Going forward, economic conditions will play a key role in directing the credit performance of RMBS.
“Inflation remains abnormally high, but GDP and unemployment remain resilient,” noted DBRS Morningstar. “If a recession comes with higher unemployment, it would have an adverse effect on credit performance.”
Credit performance, as measured by delinquencies and losses, improved throughout 2022, but that improvement has effectively bottomed out. The risk of drifting away from historically low levels is more likely, given the cloudy economic conditions, DBRS explained.
