Why Some Mortgage Bonds Can Return More Than Par
- Jonathan Poyer
- 6 hours ago
- 2 min read
A good time to revisit this video regarding the math behind write-backs on seasoned mortgage bonds. Why?
We expect the Fed to lower rates or hold them at the least.
Lower short-term rates generally improve excess spread within many seasoned non-agency RMBS structures.
More excess spread can accelerate loss writebacks where the deal documents allow.
Investors are increasingly looking beyond traditional bond sectors as corporate credit spreads remain historically tight.
This makes understanding the embedded structural value in seasoned mortgage credit more important than it has been in years.
One of the most common assumptions in fixed income is that a bond's upside ends at par. While that's true for most bonds, seasoned legacy non-agency residential mortgage-backed securities (RMBS) can be different.
In this video, portfolio manager Garrett Smith explains how certain pre-2008 mortgage bonds may continue creating value through loss writebacks. During the financial crisis, many of these securities absorbed losses as homeowners defaulted. However, as the underlying mortgage pools continue to generate cash flow and excess interest, portions of those previously recognized losses can be reversed, increasing the amount ultimately returned to investors.
The important takeaway isn't the accounting mechanics—it's the investment implication.
When investors see a seasoned RMBS trading at 70 cents on the dollar, they often assume the maximum appreciation is the remaining 30 points back to par. In reality, some bonds may ultimately return more than their current face value if contractual loss writebacks occur. That means the potential value can be greater than simply "discount to par."
This isn't true for every mortgage bond, and it certainly isn't true for most areas of fixed income. It depends on the structure of each individual security, the amount of excess spread being generated, and the contractual provisions governing writebacks.
As credit performance has remained resilient and many seasoned mortgage pools have continued to build collateral protection, these often-overlooked structural features have become increasingly relevant.
Sometimes the most attractive opportunities in fixed income aren't found by chasing yield—they're found by understanding the structure.
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