Buy All Securitized Debt as Market to Shrink by $270 Billion, BofA's Says
Investors should be buying bonds in all categories of U.S. securitized debt, in part because the market will continue to shrink next year, according to Bank of America Merrill Lynch analysts.
“We recognize that heading into 2011, recommending an overweight of all sectors of securitized products may appear exceedingly bullish,” the New York-based analysts led by Chris Flanagan wrote in a year-end outlook published Dec. 3. “However, the return performance for 2010 indicates that would have been the appropriate strategy for this past year.”
Securities backed by loans and leases, including government-backed agency mortgage bonds, have outperformed U.S. Treasuries by 2.58 percentage points this year, with some commercial-mortgage debt gaining almost 50 percent, according to Barclays Capital index data. Those excess returns, the second- best in at least 10 years, are more than double the gains of corporate bonds relative to similar-maturity government debt.
U.S. securitized debt may contract by $270 billion next year, led by a drop in non-agency home-loan bonds that lack government guarantees, according to the Bank of America analysts. Issuance will be limited as potential borrowers and investors remain wary and new regulations curb sales, while defaults eliminate outstanding debt, they said.
Net supply of corporate bonds may total $346 billion and the Treasury market may expand by $1.4 trillion, the analysts estimated.
The securitized-debt market will contract by an estimated $629 billion this year, compared with about $1 trillion of growth in each of 2006 and 2007, according to Bank of America. Net supply across U.S. fixed-income markets will probably total $1.1 trillion in 2010, down from a record $2.4 trillion in 2007.
Securitized debt outperformed Treasuries with maturities similar to its projected lives by a record 7 percentage points last year, as bonds rallied from record lows reached after the global financial crisis, according to Barclays index data, which doesn’t include all types of notes.
The Bank of America analysts’ “top picks” for 2011 in the market include “weaker and lower credit” commercial-mortgage securities, as well as interest-only slices of agency home-loan securities that will gain as homeowner refinancing slows.
Flanagan said in a telephone interview that the securitized-debt market also stands to be bolstered by a “slow, steady” U.S. economic recovery.
Risks include a possible intensification of Europe’s sovereign debt crisis or currency fluctuations, he said. While such events outside the market may cause yields on U.S. securitized debt to widen relative to benchmark rates, spreads will probably narrow afterward, he said.
In a survey by Institutional Investor magazine this year, Flanagan’s team was the second-ranked for consumer asset-backed securities, and third-ranked for real-estate asset-backed securities and non-agency mortgage-backed securities.
Recommending investors get “overweight” in particular bond categories typically means suggesting that they hold more of the debt than found in benchmark bond indexes.
JPMorgan Chase & Co. analysts, who were top-ranked for a number of securitized-debt categories in the Institutional Investor survey, suggested in a Nov. 24 report that investors buy several types of the debt, including non-agency home-loan bonds and unusual asset-backed securities, also in part because of declining supply.
At the same time, an additional $200 billion to $250 billion of debt may emerge in the agency mortgage-bond market on top of “traditional supply,” JPMorgan analysts led by Matt Jozoff wrote in their 2011 outlook.
This “shadow supply” will come from refinancing and home sales by consumers with loans backing securities currently held by the Federal Reserve, Fannie Mae or Freddie Mac, they said. The Fed bought $1.25 trillion of mortgage bonds in a program that ran from January 2009 through March of this year to bolster the housing and financing markets.
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