RMBS market likely to be further weakened by headwinds in 2023

The U.S. residential mortgage-backed securities (RMBS) market continues to look bleak for 2023. This year, RMBS issuance volumes are expected to contract further from 2022 due to the impact from elevated rates, high inflation and recession possibilities. 

Major factors that will shape the RMBS market include a dramatic reduction in origination volume and mortgage lenders exiting the business , according to a report from DBRS Morningstar on the outlook of the industry. 

A slew of lenders have exited the business recently, and others have significantly reduced downsized operations, especially in the nonbank financial sector, the report said, while noting that “industry capacity and capital availability, especially for unconventional sectors, will provide 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 collateral that was available to support securitizations in both the agency and non-agency secondary markets.

Interest rate stability offers the best environment for MBS performance, and inflation reduces the demand that investors have for mortgage-backed bonds. Consequently, as demand drops, mortgage-backed securities prices fall, which results in lenders increasing interest rates.

Against the backdrop of “home price declines, high inflation and potential volatility owing to changing economic conditions and geopolitics,” issuance volume of RMBS transactions will decrease about 40% to $61 billion across the prime, non-prime, and credit-risk transfer (CRT) segments 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 across the RMBS sectors, resulting in unfavorable pricing and deterring some market participants from entering the securitization pipeline,” KBRA stated. 

The private-label MBS market is also set to face continued headwinds in 2023, continuing the dampened momentum with the Fed’s MBS-purchase policy and volatile rates.

In particular, higher government-sponsored enterprise (GSE) conforming loan limits will curb non-agency share and securitizable production with the recent change in loan ceiling limits, DBRS noted in its report. 

The Federal Housing Finance Agency (FHFA) raised the baseline conforming loan limit for mortgages backed by Fannie Mae and Freddie Mac to $726,000 in November, an increase of 12.21% compared to 2022. In designated high-cost areas, Fannie Mae and Freddie Mac now buy mortgages over $1 million for one-unit properties amid a rise in home prices year over year.

Elevated loan ceiling limits will “theoretically mean that incrementally more industry volume would qualify for conventional loans,” the report said. 

The “esoteric RMBS” – including reverse mortgage, home equity line of credit (HELOC)-backed deals and private-label securitization (PLS) credit risk transfers (CRT) – may provide a silver lining in 2023, according to KBRA.

While such offerings are not immune to economic conditions, KBRA expects the negative impacts to these sectors will be less than prime, non-prime and agency CRT deals. 

“For example, regarding HELOC-backed deals or second liens, we expect an increase in issuance as many borrowers maintain a position of increased home equity built over the past several years,” KBRA noted.

HELOC originations grew from low levels for both bank and newer-to-market nonbank financial lenders, with a few home equity RMBS deals coming to market, Youriy Kouudinov, senior vice president of U.S. RMBS at DBRS Morningstar said in a report. He expects newer nonbank financial HELOC products to see borrower uptake with product features helping temper credit risk. 

“For 2023, HELOC originators may see securitization as an attractive exit strategy as significant homeowner equity availability still exists, and lenders can price at current rates,” Kouudinov said.

Going forward, economic conditions will play a key role in the direction of RMBS credit performance.

“Inflation remains abnormally high, but GDP and unemployment remain resilient,” DBRS Morningstar noted. “If a recession with higher unemployment emerges, it would have an adverse effect on credit performance.”

Credit performances, as measured by delinquencies and losses, improved throughout 2022, but that improvement has effectively bottomed out. The risk of moving away from historically low levels is more likely, given the cloudy economic conditions, DBRS explained.

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