Market Analysis – 64111607 – Mortgage-backed security

Executive Summary

The global Mortgage-Backed Security (MBS) market, with a current estimated total addressable market (TAM) of $13.5 trillion, remains a cornerstone of the fixed-income landscape. The market has experienced a contraction with a 3-year CAGR of est. -1.5% due to aggressive monetary tightening, which has suppressed mortgage origination and repriced existing securities. The single greatest near-term factor is central bank policy; the Federal Reserve's ongoing management of its balance sheet (Quantitative Tightening) presents both a significant threat to market liquidity and a potential opportunity for discerning investors as yields adjust.

Market Size & Growth

The global MBS market is dominated by the United States, which accounts for over 90% of the total outstanding value. The market's growth is intrinsically linked to housing market activity and prevailing interest rates. Following a period of rapid expansion fueled by low rates, the market is now in a consolidation phase, with a projected 5-year CAGR of est. 1.0% - 2.0% as interest rates are expected to stabilize at a higher plateau. The three largest geographic markets are the United States, the United Kingdom, and Canada.

[Source - Securities Industry and Financial Markets Association (SIFMA), Jan 2024]

Key Drivers & Constraints

1. Monetary Policy: Central bank interest rates are the primary driver. The recent cycle of rate hikes beginning in 2022 significantly increased borrowing costs, slowing mortgage origination and reducing the supply of new MBS. Future Fed pivots will dictate market direction.
2. Housing Market Dynamics: The volume of new and existing home sales directly determines the supply of underlying mortgages for securitization. Current high mortgage rates have cooled housing turnover, constraining the creation of new MBS pools.
3. Credit Spreads & Investor Demand: Investor appetite for yield and safety dictates demand. In times of economic uncertainty, spreads on non-government-backed (Private Label) MBS tend to widen, while demand for government-guaranteed Agency MBS increases.
4. Prepayment Risk: The risk of homeowners refinancing or paying off mortgages early is a core component of MBS valuation. In the current high-rate environment, prepayment risk is historically low, which provides cash flow stability but limits potential upside from refinancing waves.
5. Regulatory Framework: The market, particularly in the U.S., is heavily regulated post-2008. The dominance of Government-Sponsored Enterprises (GSEs) like Fannie Mae and Freddie Mac creates a bifurcated market between high-quality "Agency MBS" and higher-risk "Private Label MBS".

Competitive Landscape

The MBS market is dominated by large, money-center banks with significant balance sheets and sophisticated trading operations. Barriers to entry are extremely high due to immense capital requirements, complex regulatory licensing, and the need for advanced risk-modeling infrastructure.

⮕ Tier 1 Leaders (Issuers/Underwriters) * JPMorgan Chase & Co.: Dominant market share in underwriting and trading, leveraging a massive balance sheet and global distribution network. * Goldman Sachs: Leader in structuring complex MBS products, including non-agency and commercial MBS (CMBS), known for its trading and risk management prowess. * Bank of America: A top player in origination and securitization, benefiting from its large retail banking and mortgage lending footprint. * Citigroup: Strong global presence in structuring and distributing MBS, with particular strength in international markets.

⮕ Emerging/Niche Players * Cantor Fitzgerald: Strong niche player in MBS trading and sales, known for its focused expertise and institutional client relationships. * Annaly Capital Management, Inc.: A large mortgage REIT (mREIT) that is a major investor in, and creator of, MBS, influencing market liquidity. * Redwood Trust, Inc.: Specializes in the private-label (non-agency) space, securitizing jumbo and other non-conforming loans.

Pricing Mechanics

The price of an MBS is the net present value of its expected future cash flows, derived from the principal and interest payments of the underlying mortgage pool. Prices are quoted relative to par (a value of 100), with the key valuation input being the "yield-to-maturity," which is benchmarked against a comparable-duration government bond (e.g., the 10-Year U.S. Treasury). The spread over the benchmark rate, known as the Option-Adjusted Spread (OAS), compensates investors for the unique risks of MBS, primarily prepayment risk.

Valuation models (e.g., the PSA model) are used to forecast prepayment speeds based on interest rate movements, homeowner equity, and seasonality. A faster assumed prepayment speed shortens the security's duration and lowers its value in a premium-priced environment, while a slower speed has the opposite effect. The market is highly sensitive to economic data that influences these inputs.

Most Volatile Cost Elements: 1. 10-Year U.S. Treasury Yield: The primary benchmark for pricing. Recent Change: Increased ~150 basis points from mid-2023 to late-2023 peaks. 2. Option-Adjusted Spread (OAS): Reflects credit and prepayment risk premium. Recent Change: Widened by est. 15-25 basis points during periods of banking stress in 2023. 3. Mortgage Rate Spreads: The spread between the 30-year mortgage rate and the 10-year Treasury yield. Recent Change: Reached multi-decade highs of over 300 basis points in 2023.

Recent Trends & Innovation

• Quantitative Tightening (QT): The U.S. Federal Reserve has been allowing its MBS holdings to mature without reinvestment since June 2022. This removes a key source of demand from the market, putting upward pressure on yields and increasing volatility.
• Resurgence of Non-QM MBS: With mortgage rates rising, the market for Non-Qualified Mortgage (Non-QM) securities has grown. Issuers are securitizing loans made to borrowers with unique income profiles (e.g., self-employed) who fall outside traditional agency guidelines (2023-Present).
• AI in Risk Modeling: Leading issuers and investors are increasingly deploying artificial intelligence and machine learning to develop more sophisticated prepayment and credit default models. This allows for more granular analysis of borrower behavior at the individual loan level (2022-Present).

Supplier Landscape

Regional Focus: North Carolina (USA)

North Carolina, particularly the Charlotte and Research Triangle regions, represents a robust source of high-quality mortgage collateral for MBS pools. The state's strong net in-migration and healthy job growth in the finance, technology, and life sciences sectors fuel consistent housing demand. This provides a steady stream of conforming loans eligible for securitization into Agency MBS. The local presence of major financial institutions, including Bank of America (HQ) and Truist (HQ) in Charlotte, provides significant local capacity for mortgage origination, servicing, and capital markets activity. The state's stable regulatory and tax environment is highly supportive of the financial services industry, ensuring a reliable operating landscape.

Risk Outlook

Actionable Sourcing Recommendations

1. Prioritize Agency MBS for New Allocations. Given high price volatility and recessionary risk, focus >90% of new capital on MBS explicitly guaranteed by Ginnie Mae, Fannie Mae, or Freddie Mac. This strategy mitigates credit default risk and ensures superior liquidity, aligning with a capital preservation mandate in an uncertain macroeconomic environment.
2. Utilize the TBA Market for Tactical Execution. Leverage the "To-Be-Announced" (TBA) market for efficient trade execution and portfolio duration management. Its high liquidity (>$200B daily volume) and forward-settling nature allow for precise adjustments to interest rate exposure and cash management without the burden of immediate specific-pool analysis.