Flash Insights: Tired of tariffs? Try securitized bonds

US President Donald Trump’s “Liberation Day” announcement created a great deal of disruption across markets as investors digested the impact tariffs could have on the many players involved in the global supply chain. Amid this chaos, it is worth pointing out that many securitized assets are largely isolated from the noise of the trade war because they are mostly domestic (United States) and are less exposed to the uncertainties facing corporate balance sheet and cash flows.

Below, we consider the potential impacts tariffs have on three large subsectors within the securitized space:

• Non-agency RMBS (residential mortgage-backed securities)
• CMBS (commercial mortgage-backed securities)
• Agency MBS (mortgage-backed securities guaranteed by Fannie Mae/Freddie Mac/Ginnie Mae)

First, we should acknowledge that this is a somewhat fundamental dissection where we consider the impacts on underlying losses in various outcomes. As with every sector, securitized assets are also exposed to mark-to-market uncertainty,¹ but we think certainty around fundamental outcomes can help drive investment decisions in these uncertain times. Also, it is also worth noting that we don’t think a repeat of the 2008 global financial crisis (GFC) is in the cards, and a Prime Minister Liz Truss (a la the United Kingdom) moment for the United States is unlikely. However, all bets are off if these highly improbable scenarios occur.

All else equal, tariffs should provide an upward impetus to real asset prices—such as housing, commercial property and automobiles—by increasing the costs associated with their manufacture. Since these assets serve as collateral for securitized bonds, the asset’s value plays an important role in forecasting the potential losses that may flow through the capital stack.² Thus, on the margin, a pickup in the value of real assets is a net benefit to these securitized bonds.

Focusing on residential housing in particular, analysts estimate tariffs will likely increase construction costs for new housing in the range of 4%-7%.³ This incorporates the direct impacts on imported construction goods, as well as the knock-on effects on domestically produced construction goods. This anticipated increase comes at a time when housing inventory is still constrained across most of the country. Meanwhile, the administration’s crackdown on illegal immigration will likely impair the labor supply in the construction sector, which would further exacerbate price increases in home construction.

Considering the potential for increased construction costs amid already low housing inventory levels, we think it is highly unlikely that home prices will experience dramatic declines in value on a nationwide basis.

• Higher-rate environment: In recent years, we have seen home prices remain resilient despite a higher-rate environment and lack of affordability, as the marginal buyer has quickly absorbed up the marginal inventory. We think this will remain true, even if interest rates rise due to a stagflationary environment.
• Lower-rate environment: If recessionary concerns drive the United States into a lower interest-rate environment, we think the resulting increase in affordability would at least partially offset any defaults or delinquencies related to rising unemployment. For example, a 50 basis points decrease in mortgage rates allows a homebuyer to afford a home that is 5% higher in value, while keeping their mortgage payments the same, and could act as a powerful backstop to home price declines. To contextualize a potential inventory rise in a recession, an increase in the unemployment rate to 6% would mean about 3 million jobs lost. Given a 65% homeownership rate, and 50% split between dual-income vs. single-income households, this would mean a potential rise of 1 million housing units from forced sellers. This estimate ignores cure rates, modification rates, etc., and is likely a significant overestimate. Yet, we can compare this to estimates of structural home shortages in the United States, which run from 4 million to 7 million. Even the newly unemployed will eventually need shelter. Further, the manner in which this increased inventory hits the market will be important. Servicers in the United States have moved to loan modifications as a major tool for delinquency management, rather than seeking foreclosures as was done in the post-GFC years. This approach is based in part on the lessons learned from the GFC itself, such that forced foreclosures have limited benefits to the broad ecosystem. 

As such, we feel confident in the fundamentals supporting non-agency RMBS in a wide range of macroeconomic outcomes related to rates and employment.

For similar reasons, we expect increased property values for commercial real estate. However, rate outcomes can have a particularly notable impact on the CMBS sector, from both a capitalization rate and cost-of-financing standpoint.

• Lower-rate environment: Given the recent rate rally, more cash-flowing assets can be refinanced. Furthermore, servicers can use loan extensions for troubled loans to allow commercial owners time to restructure liabilities and stabilize or dispose of assets. As a result, modestly lower rates without a truly catastrophic unemployment or corporate earnings scenario are generally beneficial.
• Higher-rate environment: Higher rates due to inflation might provide owners the ability to pass on increased costs to tenants, as long as growth continues. However, a stagflationary environment would be detrimental to the sector.

Overall, we continue to think attractive opportunities exist in the CMBS space that stand to benefit from higher property values and lower rates and yet are idiosyncratic/uncorrelated enough to withstand a return to higher rates like the ones we have recently seen.

Finally, on the agency MBS front, starting valuations are already seem more attractive than investment-grade corporate securities. In addition, structurally levered securities backed by agency MBS, such as agency IO (interest-only), also offer interesting investment outcomes.

• Lower-rate environment: Agency MBS have historically outperformed in recessionary environments accompanied by lower rates as they have no credit risk. For agency IOs, the mortgage rate of the underlying loans will play an important role. As is well known, a very large majority of homeowners have mortgage rates less than 4%, and as a result, we think IO backed by these seasoned loans will likely continue to perform relatively well in most lower-rate environments. In particular, a recessionary environment have historically tended to slow refinancings on the margin, irrespective of the mortgage rate available in the market. This is due to credit concerns from originators, who instinctively tighten their credit box⁴ and only originate to the highest-quality borrowers.
• Higher-rate environment: If rates head back higher, given the wider valuations and the likely reduced supply, we continue to think agency MBS are a better investment than investment-grade corporates and serve as a bulwark against earning and outlook uncertainty in the corporate market. Agency IO could stand to immediately benefit from higher rates as refinancing gets cut off.

Importantly, as we’ve tried to highlight above, these three sectors often provide counteracting and diversified benefits under various macroeconomic outcomes and should be considered together in a portfolio for these reasons. In summary, we believe that the securitized space may provide some relief in which to ride out this trade conflict.