Investment pros think mortgage-backed securities will fare better in the next few months after a lackluster first quarter.
"The first quarter may have been the worst for this year. I anticipate improvement," said Ken Boertzel, who helps manage $23 billion of assets at New York Life Asset Management in New York.
A positive factor is decreased supply, the upshot of a lending slump. Average monthly issuance of mortgage-backed bonds in the first quarter was $26 billion, off 66%, said Michael Youngblood, a managing director at Banc of America Securities in Charlotte, N.C.
Mortgage-backed bonds are likely to outperform corporate bonds, Mr. Youngblood said. "Mortgage credit quality is as good as it has been in 20 years, and the credit quality of the corporate sector is under pressure."
The junk-bond sector has had a number of failures and defaults since last year, he said. And the high-grade corporate bond sector is facing "event risk" due to corporate buyouts, in which the buyer incurs higher expenses after borrowing money to close a deal and therefore becomes riskier.
Worries also have arisen about the credit quality underlying bonds backed by commercial mortgages. In such an environment, home-loan-backed securities that carry quasi-governmental guarantees look like a safer bet.
"Residential MBS don't have a lot of the potential land mines that you find in alternative investments" such as corporate bonds or commercial-mortgage-backed issues, Mr. Boertzel said.
Despite the optimism over mortgage-backed securities, they have had a tough year so far. The market reeled in February after Gary Gensler, under secretary of the Treasury for domestic finance, intimated that Fannie Mae and Freddie Mac are not guaranteed a federal bailout in the event they incur huge losses. Investors' belief that Fannie and Freddie are virtually immune to default has allowed the two government-sponsored enterprises to price their corporate debt and mortgage-backed issues favorably.
After the Gensler statements, prices of both agency debt and conventional-mortgage-backed securities fell and yields rose. They have not recovered. And despite remarks from Mr. Gensler supporting regulatory changes at Fannie and Freddie, Wall Street analysts feel there will not be any such change in the next two years.
Another problem for mortgage-backed issues has been the Treasury's buying back its own debt. When the Treasury bought back $1 billion of its bonds in February, investors scrambled to buy them, driving down yields. Investors demanded higher yields from other fixed-income investments to make up for the lower Treasury yields.
Mortgage-backed bonds "had to go to higher yields because the Treasury yield was artificially constrained due to low supply," Mr. Youngblood said.
Mr. Boertzel said that when the buybacks were announced, investors did not know how they would work and bought Treasuries heavily, without regard to relative value. But in last week's $3 billion Treasury buyback, investors, having learned how the process works, did not scramble to snap up Treasuries as they had in February, he said.