Private Mortgage Bond Market Shows Signs of Life

Main Street and Wall Street don’t seem to agree on much these days, but the two sides have a shared interest in the health of the market for something called “private label” residential mortgage bonds.

At the peak of the market, these bonds funded the lion’s share of U.S. home lending, but they now represent the last securitized market to recover since the financial crisis. In addition to conservative ratings, issuers also complain of unfolding regulation and lingering investor distrust of the type securities at the heart of heavy losses in recent years.

But now the market for such bonds made during the easy-lending era is improving, possibly reflecting growing confidence in the economy. That could aid the recovery in new mortgage bond issuance that Wall Street says is crucial to housing’s recovery.

A survey by J.P. Morgan Chase & Co. this week found that 67% of 106 investors surveyed from Tuesday to Thursday said yield spreads would be tighter over the next six months for these bonds, known as RMBS, indicating investor interest is growing.

The market for private-label RMBS has invoked strong emotion over the past few years, being the source of both strong gains and losses on the debt that remains exposed to heavy losses from delinquencies and foreclosures.

Last year, investors were bullish in the first four months before a batch of selling by the Federal Reserve Bank of New York and the deepening debt crisis in Europe led investors to flee risky bets.

A major difference between last year and 2012 is the type of investor that has been buying, according to at least two major dealers and investors including BlackRock Inc. and TCW Group Inc. These buyers have lower yield requirements than the “fast money” hedge funds, leaving yields that have shrunk to near 6% still a relative value compared with other assets they could buy, such as junk-rated corporate bonds, they said.

“I think the market still tightens, generally, barring exogenous factors,” said John Sim, a strategist at J.P. Morgan in New York. “There’s nothing really out there that will cause things to widen. You are seeing that, more and more, the selling is from fast money (such as hedge funds)” to long-term holders.

Trading data also suggest that bullish buyers haven’t changed their views. Investors bought $21.3 billion in subprime and other risky residential mortgage bonds through Wall Street dealers this month, exceeding the $20.4 billion they sold, according to data from the Financial Industry Regulatory Authority, or Finra.

“If somebody’s made a lot of money, it’s prudent to take some chips off the table but that doesn’t mean it’s the same story for everyone,” said Randy Robertson, co-head of securitized products at BlackRock in New York.

In aggregate, the data indicate that dealer inventory has grown this year, creating some concern among investors who consider that statistic a gauge of demand. But the level has grown from a low base last quarter, and pales next to what the dealers had in the spring of 2011, based on anecdotal comments from investors and dealers. Finra began reporting volume in mid-2011.

“Dealers are far lighter than they were at the end of last year, so you’ve really mitigated the risk of dealers forced to dump this paper,” said Bryan Whalen, a managing director at TCW in Los Angeles.

To be sure, TCW has “taken a touch off” its nonagency bond holdings but remains bullish after seeing a constructive, not manic, rally, he said.

“March has been the solid slight grind higher that you would want after the type of price action you saw in February,” Whalen said. “If we continued at that speed, the more likely we’d be set up for a short-term snapback.”

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