Gauging the Mortgage Trade Today

Is the mortgage trade over? No, and in some ways, it’s just beginning.

The annual returns above 20% we were seeing as markets recovered from the financial crisis are largely behind us. However, a carefully selected and managed portfolio of legacy mortgage credit—specifically nonagency residential mortgage-backed securities (RMBS) and commercial mortgage-backed securities (CMBS)—continues to look compelling, in our view, both on an absolute basis and relative to other fixed-income alternatives.

Legacy mortgage credit offers a combination of attractive attributes, including solid loss-adjusted yields; low historical correlations to other fixed-income securities and to equities; good downside protection; upside potential in a continued housing recovery driven by lower default rates; lower loss severities; and greater levels of voluntary prepayments, as fewer borrowers will be underwater.

We believe that many of these positives are not priced into valuations. While results will be very bond specific, there exists the potential for outsize returns among these credits.

But that’s not the only potential we see.

More Opportunities Could Arise as Government’s Role Shifts

A stronger and more stable footing for the housing market will enable the federal government to begin to slowly decrease its involvement in the market.

Currently, the government supports—either explicitly or implicitly—roughly 90% of new mortgage originations. This compares to an average of 63% of new originations pre-crisis.

As the government’s market share decreases toward historical levels, we expect private capital to fill the hole, creating attractive investment opportunities in newly issued mortgage credit, both nonagency securitizations and government-sponsored enterprise (GSE) risk-sharing securities.

We believe that the government’s role in housing finance—while necessary—should be limited primarily to ensuring market stability and promoting liquidity through the provision of catastrophic loss insurance behind meaningful private capital.

As we have discussed in the past, we see two potential market-based solutions that the GSEs could use to share credit risk with private investors. While the ultimate structure of the US mortgage market is far from certain, one thing we can be sure of is that, given its size of $10 trillion, even a small change in the government’s share of the market will create significant investment opportunities

.Evolution of Catalysts Driving Investment Opportunity in Mortgage Credit

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Douglas J. Peebles

Chief Investment Officer—Fixed Income
Douglas J. Peebles is Chief Investment Officer, a Partner of the firm, and Head of Fixed Income, focusing on AB’s fixed-income investment processes, strategy and performance across portfolios globally. As CIO, he is also Co-Chairman of the Interest Rates and Currencies Research Review team, which is responsible for setting interest-rate and currency policy for all fixed-income portfolios. In addition, Peebles serves as Lead Portfolio Manager for AB’s Unconstrained Bond Strategy, and focuses on managing the firm’s strategic client relationships. In 1997, he pioneered AB’s highly successful and innovative approach to global multi-sector high-income investing, which is now being adopted by other firms. Since joining the firm in 1987, Peebles has held several leadership positions, including director of Global Fixed Income (1997¬–2004), co-head of Fixed Income (2004–2008), and his current position (Head of Fixed Income), which he assumed in 2008. He holds a BA from Muhlenberg College and an MBA from Rutgers University. Location: New York

Matthew D. Bass

Chief Operating Officer—Alternatives
Matthew D. Bass is a Senior Vice President and Chief Operating Officer of AllianceBernstein’s Alternatives business, responsible for strategy, acquisitions, new product development and fundraising initiatives. Prior to joining AllianceBernstein in 2010, he was a program director at the US Department of the Treasury, where he was responsible for the design and implementation of various real estate and real estate capital-markets programs pursuant to the Troubled Asset Relief Program. Prior to joining the Treasury in 2009, Bass was a vice president at The Blackstone Group’s GSO Capital Partners unit, where he was involved in analyzing, evaluating and executing private debt and equity investments. He began his career in the Financial Institutions Investment Banking Group at UBS, where he was responsible for executing merger and acquisition advisory and capital-raising transactions for banks, asset managers and specialty finance companies. Bass holds a BS in finance from Lehigh University. Location: New York City

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