Fannie Mae-No Politics (FNMA)

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Mortgage Bets Get Riskier
As investors reach for more yield, the dangers become greater


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By
Michael Aneiro
June 28, 2014 12:20 a.m. ET

Having caused, and survived, the financial crisis, mortgage bonds are back in a familiar position: The safest offer paltry yields, and that's pushing investors into more complex structures that enhance return but magnify risk.

Since the crisis, savvy fund managers have loaded up on mortgage-backed securities (MBS), particularly those underwritten by government-sponsored enterprises Fannie Mae (ticker: FNMA ) and Freddie Mac (FMCC). These GSE bonds offer an implicit guarantee of federal government support while yielding more than comparable Treasuries. After a bull run that's seen agency-backed mortgage bonds gain 3.7% this year, they look overbought. "Agency mortgage bonds are rich," says Scott Mather, head of global portfolio management at Pimco, which has reduced its holdings lately. "The market suffers from weak origination and the Fed is buying everything that's produced."
Being rich doesn't distinguish them from a lot of other bonds today, but it means that fund managers who rode agency mortgage bonds to steady, low-risk gains in recent years need new tactics.

Non-agency mortgage bonds–private-market securities that lack government support–have had time to heal since causing the financial crisis, and big bond shops, which pride themselves on the sort of technical credit analysis these securities require, have found bargains along the way.

"The non-agency mortgage market is an all-legacy market of stuff left over from the last cycle," says Tad Rivelle, chief fixed-income investment officer at TCW, who manages the $30 billion MetWest Total Return fund (MWTRX). Rivelle says these securities now combine 5% or 6% yields with some upside. "You want securities that you can feel good about owning for the long term."

Bill Irving, who oversees $34 billion in mortgage and government bonds at Fidelity, likes some newer market areas. He says real-estate investment trusts and private- equity shops have been buying homes and renting them out, and they've sold floating-rate bonds to finance the purchases.

"The repayment of the debt is securitized by the homes, and we think the credit quality is very high," Irving says, adding that Fidelity sees growth potential for the sector.

Another niche market involves companies that buy nonperforming mortgages from banks at a discount and either negotiate payment plans with the homeowners or foreclose and refurbish the homes to sell. "Basically, the bond gets paid off as they liquidate the properties," Irving says.

MUCH OF THE MORTGAGE market's future still depends on the trajectories of the big GSEs, which once looked likely to be dissolved in favor of private securitization, perhaps like the bank-issued covered bonds that predominate in Europe. Now it looks as if GSEs are here for the long haul, and they've branched into new products, namely so-called risk-sharing MBS. Since last year, Freddie Mac has offered a handful of bonds under a new program called Structured Agency Credit Risk, while Fannie Mae has offered three bonds under a similar program. The basic idea is to slice up the credit risk of underlying mortgage bonds and share it with investors at different levels.

"The liquidity and depth of the GSE market is second only to Treasuries, and this is one way to keep the market as it is and transfer some of the risk to the private market," says Irving, who observes that such alternative types of bonds "could be the future of housing finance." Still, he's skeptical of the current offerings. "You could easily imagine a scenario in which they get impaired," he says.

Vitaliy Liberman, who manages MBS portfolios at DoubleLine, has steered clear of these bonds so far. "The initial issuance was really clean [collateral] as they try to prime the pump and build a market," he says. "It will be interesting to see whether they start to reduce the quality of the collateral from here."


http://online.barrons.com/news/articles/SB50001424053111904544004579642560520709496