It’s worth doing the maths on Residential Mortgage Backed Securities (RMBS) for those of you wanting to increase your investment grade allocation or looking to re-invest some of those Swiss Re maturities. This note includes a link to an educational webinar
Residential Mortgage Backed Securities (RMBS) are some of the best relative value securities available at the moment. Investment grade corporate bond yields continue to compress, making many less attractive than they once were.
Just a few weeks ago, one of our senior staff, Mark Bayley, together with George Whittle drafted a note suggesting investors in Qantas bonds consider taking profits as yields were low. In a separate note, WA State Manager, Darryl Bruce also suggested selling Qantas bonds.
One of our favoured options is to switch from investment grade corporate credit into investment grade RMBS, rated in the single A range but showing attractive yields over the benchmark of around 200bps to 315bps generating total yields around 3.7% to 4% per annum. By comparison, the Qantas bonds maturing 2020, 2021 and 2022, are rated circa three notches lower and have yields of 3.5% per annum or less depending on the term to maturity.
Year to date issuance of RMBS is $11.72bn and for the month of May $2.62bn, some of which is indicative. But early signs show total issuance could be higher than last year. See Appendix 1 Australian RMBS issuance to date.
Source: Macquarie debt market analysis
Note: Australian RMBS issuance – non AUD volumes have been converted to AUD equivalent volumes using the exchange rate at the time of issue.
A word of caution to would be investors – watch your portfolio allocations and make sure you have enough diversity especially those of you that already invest in residential property - you may already have enough exposure in your portfolios to the banking sector.
Why we like RMBS
- There are a range of risk/ rewards available, so investors can identify levels they want to target.
- Yields offer good relative value on a comparative basis.
- Very broad range of issuers including APRA regulated and non regulated institutions, who use RMBS as a source of funding.
- Four measures to help prevent losses being passed onto bondholders:
- Excess spread – RMBS transactions charge a slightly higher rate of interest than what they pay out to investors, with any excess spread flowing back to the issuer. If losses are incurred this excess spread can be used to absorb them.
- Overcollateralisation– the assets securing the mortgages are worth more than the amount being lent.
- Lenders’ mortgage insurance (LMI) – a dominant feature in prime Australian RMBS. Borrowers wanting to borrow more than 80% of the value of the property are required to take out mortgage insurance for the benefit of the lender in case of default.
- Subordination – a strict priority of payments schedule and loss absorption protects investors at the top of the trust’s capital structure. In practice any losses that aren’t covered by excess spread are recognised by writing down the principal value of the most junior tranche, which continues until that tranche has been completely written down, then the next most junior tranche starts to incur losses.
- High underwriting standards
- Full recourse to the borrower, if selling the property can’t recover the borrowed amount.
If you are new to RMBS and want to learn more, please let your dealer know. Periodically we have speakers who cover the topic.
Read The Australian Guide to Fixed Income – Chapter 12
Listen to the RMBS Webinar – While a few years’ old (including pricing) the principles still apply
Note: We make RMBS available to wholesale investors only from $50,000. While we often have RMBS parcels to sell, they are popular and sell fairly quickly. If you are interested in RMBS please let your dealer know.
Appendix 1 – RMBS deals announced since January 2017
Source: FIIG Securities, KangaNews
Accurate as at 26 May 2017