Mortgage and Structured Products Trader: Extension Risk Returns

The report highlights the re-emergence of extension risk and convexity selling in the Agency MBS market as Treasury yields rise. It recommends favoring CES RMBS over non-QM and Aircraft ABS over subprime auto due to better fundamentals and technical resilience.

Key Takeaways

• 1.Elevated Treasury yields have re-introduced significant extension risk in Agency MBS, specifically in higher coupon loans (FN 6.0s-6.5s).
• 2.Closed-end second lien (CES) RMBS are preferred over non-QM owing to superior borrower quality and more favorable convexity profiles.
• 3.Aircraft ABS valuations remain well-supported by supply/demand imbalances in the airline sector, making them more attractive than subprime auto ABS.

Table of Contents

• Agency MBS
• Nascent convexity selling flows re-emerge
• Normalization in primary-secondary spreads can boost mortgage rates and accelerate extension risk/convexity hedging needs further
• Fixed income fund may encounter outflow pressures should 10-year Treasury yields exceed 4.8-5.0%
• At current mortgage rate levels, premium coupons face the greatest extension risk
• Overseas demand was surprisingly weak in March
• RMBS
• CES: Fundamentals support continued attractiveness
• ABS
• Aircraft ABS: Finally taking off or grounded yet again?
• Forecasts
• Relative Value Views
• Cross-Asset Valuations

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