Private-label securities are in demand as investors bet Fed peak is reached

Federal Reserve Chair Jerome Powell indicated in recent congressional testimony that interest rate hikes are now likely at the “peak for the current tightening cycle,” after signaling in November of last year that the Fed was close to the end of its war on inflation.

For investors in the private-label securities (PLS) market, the earlier signal was enough to unleash a boatload of money that had been sitting on the sidelines waiting for the “peak” to arrive, according to several market experts interviewed recently by HousingWire. 

“November really signaled that the [Fed’s] shock-and-awe campaign is over,” said Peter Van Gelderen, a specialist portfolio manager in the fixed-income group and co-head of Global Securitized at TCW, a leading global asset management firm with some $210 billion in assets under management. 

“Since November, there’s greater certainty by the investment community that the hiking cycle is done and that the economy is not falling off a cliff, that the housing market is not falling off a cliff.

“And so [investors] can start having greater conviction in the future path of interest rates and in the health of the mortgage market.”

Michael Warden, managing principal and CEO of Invictus Capital Partners — one of the largest players in the nonqualified mortgage (or private-label) securitization space via Verus Securitization Trust — is also quite bullish on the future of private capital in the mortgage market. 

Non-QM mortgages include loans that cannot command a government, or “agency,” stamp through Fannie Mae or Freddie Mac. The pool of non-QM borrowers includes real estate investors, fix-and-flippers, foreign nationals, business owners, gig economy workers and the self-employed.

“The rating agencies and bond market have recognized the pristine nature of [residential mortgage-backed securities, or RMBS] and are rewarding that over time with tighter and tighter spreads, which allows for better financing, which then allows for better pricing ultimately back to the borrower,” Warden said.

“My guess is we’ll do 10 or 11 deals this year in the $5.5 billion to $6 billion range [in total value] — maybe a little more.” 

Warden added that Invictus has had increasing participation from bond investors in its deals and now averages about 40 investors per transaction, “so our participation is really high.”

Alexander Suslov, head of capital markets at A&D Mortgage, said the Florida-based lender is now working on its second private-label securitization deal of this year. He expects the company to stay on a pace for an offering every two months in 2024. 

“Overall, you know, we’re going down the hill [in the rate cycle],” he said. “It’s a matter of speed. … Our analytical team believes we’re approaching a bull market as far as fixed-income [securities].”

Keith Lind, CEO of Acra Lending, a leading non-QM lender, said the PLS market is “fully healthy and functional, and I think it’s going to get better.” 

“There’s a lot of demand from investors that want to buy these bonds backed by non-QM, but there’s only so many loans to be bought to securitize,” Lind said. “And future rate cuts mean less return [for investors].

He noted that investors can lock in today at a higher interest rate, but three or four months from now, the rate might be lower once the Fed starts cutting benchmark rates.

“So [investors] want to lock in these higher returns today, and that’s why there’s a lot of demand for these [securities] that are out in the market right now.”

Upward adjustment

The Kroll Bond Rating Agency (KBRA) issued a recent report covering what it calls RMBS 2.0 — encompassing the prime jumbo, nonprime/non-QM and home equity lending space, as well as credit-risk transfer deals. The report revealed that January 2024 PLS issuance totaled $7.5 billion, up 81% from the same month last year.

“Given Q1 2024’s strong start, we estimate total issuance could reach $20 billion — which would be the highest-issuance quarter since Q2 2022 — exceeding our earlier expectations by nearly $8 billion,” the KBRA report states.

“We also forecast Q2 2024 to follow with robust issuance at nearly $20 billion as the resultant spread tightening and market conditions draw issuers back to the market.

KBRA expects fiscal year 2024 issuance for RMBS 2.0 to be approximately $67 billion, up 22% year over year. Home equity lines of credit (HELOCs) and closed-end second (CES) mortgage deals are expected to account for $11 billion of the increase.

“Despite the relatively high interest rate environment, elevated inflation rates and housing-affordability concerns, the RMBS [or PLS] sector appears to be having a rebound from a sluggish 2023,” KBRA stated.

Warden said the largest buyers of triple AAA, or top-rated, RMBS are generally the large money managers. 

“Almost all of them are participating,” he added. “Generally, you find a lot of those same investors buying all the way down [the capital stack] as well. 

“But then you also add in hedge funds and other private equity-type funds that are looking for a bit more yield to satisfy their capital requirements.”

Van Gelderen explained that some of these investors used to be active players in the commercial mortgage market “and nobody can figure out what’s going to happen to the commercial mortgage world.” 

It is a huge investment sector “that has all been taken away from them,” due to the post-pandemic woes afflicting commercial properties, such as office buildings, Van Gelderen said. 

“And so they have to find other places to go, and when you find other places to go, you drive up prices in those other places,” he said.

Note of caution

Ryan Craft, CEO of Saluda Grade — a real estate advisory, securitization and asset management firm — said the current driver of investor demand is the expectation that rates will go lower later in 2024 and into 2025. He added that is why so many investors are “coming off the sidelines.”

“The most interesting thing that I’ve seen from my position as an issuer [of bonds] in the market is the depth of the new buyer base that’s coming into the market,” Craft said “… A broad swath of investors has come [into the market] since the beginning of the year, so it’s been a very deep buyer base.”

Craft cautions, however, that the U.S. government is forecasting that it will need to issue some $1.8 trillion in Treasurys in 2024. He said that could throw a wrench into the overall supply-and-demand equation in the secondary market.

“The market is seeing a lot of demand on limited [bond] supply in the private-label market … but at the same time, you are seeing a huge forecast of government debt, which could be a balloon effect in keeping rates higher for longer,” Craft said. “Those two clashing dynamics will be interesting to watch in 2024. 

“So, I would say I’m cautiously optimistic, cautiously bullish right now … but I think it’s important to be cognizant of some of the other fundamentals at play.”

Ben Hunsaker is a portfolio manager focused on securitized credit for Beach Point Capital Management, a multibillion-dollar investment management firm that serves public and corporate pension funds and endowments in the U.S. and Europe. Right now, he said, there is “a lot of cash chasing bonds.”

“You had throughout the fourth quarter [of last year] like $5 billion per week in taxable fixed-income bond-complex inflows, and this year that’s accelerated to beyond $10 billion per week,” Hunsaker said. “Right now, there’s way more demand than there is supply.” 

That comes on top of the fact that life insurance companies are writing record volumes of life policies and multiyear guaranteed annuities, “and so all that crowds into the fixed-income credit markets,” he added. In the latter half of this year, a tipping point could be reached if bond supply outstrips demand.

“This is all supply and demand at the end of the day, and both supply and demand are dependent upon this one factor [interest rates],” he said.