MBS credit spreads have been widening significantly

Since the start of the FED’s tightening, credit spreads on residential mortgage-backed securities (MBS) have been widening significantly. For example, the credit spreads on junior B1 and B2 tranches of Credit Risk Transfer notes (CRT) have doubled since their 2017 lows. These junior CRT tranches absorb initial losses on diversified US agency residential mortgage-backed pools (e.g. Fannie Mae). The increased credit spreads on CRTs compensate for potential stress ahead in US housing market. However, earlier CRT vintages, in particular those issued prior to the Pandemic, have benefited from a number of tailwinds. Namely, the previous years’ low default environment, low rates (stimulating prepayments while locking up cheap funding costs) and robust house prices growth (house prices remain almost 40% above 2019-levels) have all led to robust performance and de-risking of CRTs issued prior to 2021. Given the divergence among the CRTs, an active management of any such investment, with detailed knowledge of the underlying mortgage pools, remains necessary.

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