Bank of America Merrill Lynch analysts have slashed their forecast for jumbo residential mortgage-backed bond supply by more than half after a slow start to the year for issuance.
The bank had initially forecast US$35bn of supply this year, but it now expects just US$15bn due to combination of factors - including rising interest rates in 2018 and strong house price increases - that have stifled demand for jumbo mortgages.
Tight credit spreads and healthy origination volumes had boosted growth in the market in the past couple of years.
“This trend led to much optimism for continued growth in the sector, and we had projected that Jumbo 2.0 issuance would increase further in 2019,” BAML wrote in a note.
“Unfortunately, this optimistic outlook does not appear to be materializing.”
Lenders churned out over US$22bn in new jumbo RMBS last year, including some from debut issuers such as Wells Fargo and Loan Depot. That was double the amount sold in 2017, when volumes increased four-fold compared with 2016 numbers.
The origination of jumbo mortgages, which are too big to be financed by government sponsored agencies, is more sensitive to interest rate trends than the overall mortgage market.
Rising rates in 2018 dampened demand for mortgage refinancing across the entire housing market - but more so in jumbo loans, which are bigger than the US$484k cut-off to be eligible for agency financing.
Overall originations were down 10% in 2018 relative to 2017 numbers, while jumbo originations were down 15%.
This is the main reason bond volumes are expected to drop this year, according to BAML. “House price appreciation and affordability pressures at the high end likely also contributed,” they said.
But securitization has also lost some of its appeal as a source of financing as spreads have widened, according to BAML.
The bank’s analysts estimate lenders will securitize around 4% of the mortgages they originate in 2019, which is near the low end of the range seen in recent years.
The change in pricing dynamics has been noticeable in recent deals.
In Redwood Trust’s latest issue in February, SEMT 2019-CH1, the senior Triple A tranche was priced at 125bp over interpolated swaps, according to IFR data. The issuer priced a similar tranche on its prior deal in September, SEMT 2018-CH4, at 95bp.
That said, the indication from the Federal Reserve last week that rates may remain on pause for the rest of the year could encourage originations to pick up, BAML noted.
An S&P report in March also said home price appreciation started to cool at the end of last year, which could make bigger homes slightly more affordable and encourage lending activity.
“Originations might pick up, but likely not drastically, and this increase would be from the current depressed levels,” said BAML.
