Non-Agency residential mortgage REITs generally ended the year trading at sizeable discounts to tangible book value and double-digit dividend yields. Agency mortgage REITs also ended the year with double-digit dividend yields while some mortgage servicers traded at discounts to book value in excess of 30%.
As we have said, as the year progressed, many investors have not fully recognized that many residential mortgage REITs are currently using less and longer-term non-mark-to-market leverage (often securitization) than in the time leading up to the pandemic. Most mortgage REITs and servicers are also buying back portions of their capital structure, given the distressed prices of common/preferred shares and corporate debt.
In the structured credit market, prices were down in varying degrees as credit spreads widened across the capital structure in 2022 (despite loan delinquencies remaining historically low for most sub-sectors). Longer duration securities exhibited the sharpest price declines as new issue and legacy mezzanine RMBS declined by as much as 30 points.
Non-QM, Jumbo 2.0, SFR, RPL, and legacy RMBS all ended lower in price across the capital structure, although prices flattened out in 4Q2022. CRT bucked the trend and posted relatively flat performance, largely because of coupons which float off of short-term indices. On the Agency side, the current coupon Agency MBS bond yield went from a 2.2% yield at the beginning of the year to a yield of 5.4% at year end. While the nominal Agency MBS spreads tightened in from historically wide levels in 4Q2022, it still ended December at 145bps, which is significantly wider than the historical average. In 2022, the Bloomberg MBS Index posted its weakest absolute performance on record of -12% and second worst year of relative performance versus Treasuries.
Overall mortgage loans dropped in price because of the triple whammy of higher benchmark yields, wider credit spreads, and lower prepayment/longer duration expectations.
We believe it’s a good time to be invested in residential mortgage credit – not due to potential short-term home price appreciation – but because mortgage defaults are likely to remain low and recoveries high given the current state of consumer credit. While Agency and Non-Agency MBS should likely perform well in 2023, we believe the best risk/reward exists at the bottom of the capital structure (common shares, preferred shares, corporate bonds) in certain mortgage equities. As management teams report earnings in the coming quarters, we believe investors may realize that the turmoil of 2020 was a product of a different set of circumstances than exist in today’s market. We expect that over time, these companies should maintain a relatively stable book value and that the price of their equities could revert back to historical levels, which are much closer to book value than the substantial discounts that currently exist in the market.