MBS will ‘bend, not break’ from credit score woes and a financial institution retreat

The latest mortgage-backed securities forecasts suggest 2023 will be another challenging year, but both agency and private bonds may be able to bear up under the pressures they’ll face.

For nonconforming MBS, the challenge lies in the slowly building pressure on borrowers’ ability to repay. Some forecasts have been particularly pessimistic about this, but a couple recent ones have been more hopeful.

“The improving credit trend may slip a bit, albeit remaining well-contained, absent a significant recession,” DBRS Morningstar analysts said in an outlook report.

“Right now, inflation remains abnormally high, but [gross domestic product] and unemployment remain resilient,” they noted.

Fitch also expects a durable MBS market in 2023

“Arrears are expected to increase modestly relative to 2022 but will still remain low relative to historical levels,” Fitch said in an outlook report.

Its analysts expect credit ratings to be relatively stable in part because consumers’ finances have been fortified by refinancing and home price appreciation during the last two years, which could help them weather the tougher economic conditions that lie ahead.

Meanwhile, although the continued retreat by banks from agency MBS along with the Federal Reserve’s decision last year to let its portfolio going into runoff are worrisome given those two buyer segments are the primary investors for these securities, researchers think those developments will be mitigated by other factors.

Banks are likely to continue backing out slowly, and the Fed isn’t expected to go a step further and sell bonds anytime soon, Walt Schmidt, senior vice president, mortgage strategies, at FHN Financial, noted.

“We do not think the Fed will sell MBS and banks are also not likely to sell in large numbers due to the steep unrealized losses,” he said in a report.

Also, private investment fund managers could step into breach.

“Those investors will likely see current MBS spread levels as generous relative risk-adjusted spreads in other sectors and we look for somewhat of a rotation into MBS,” said Schmidt.

In addition, market participants from overseas — which are the third largest group of investors — could help fill the gap.

“Foreign buyers may also add [MBS] if currency markets settle down and hedging becomes less expensive,” Schmidt said.

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