SNWAM continues to find the risk reward dynamic of the municipal housing revenue sector very compelling. Current economic data is positive for the sector, and both cyclical and secular demographic trends are contributing to improving credit metrics. For example, housing starts are projected to continue increasing through 2017, and new and existing housing sales data last week was positive. Demographic trends in the under 34-year-old head of household demographic is poised to support first-time home buyer demand for the foreseeable future. Demographic trends in renter occupied housing continue their cyclical reversal from lows seen in 2006. Together, these factors are supportive of a stable to positive outlook for the housing revenue sector.
The complexity of the municipal SF and MF housing sector creates inefficiencies and opportunities that SNWAM believes can add significant client value through sector allocation and security selection. The sector is comprised of three sub-sectors: single family (SF) housing mortgages, multi-family (MF) housing mortgages and one off projects. The most significant risk within the sector is the extraordinary redemption provision (ERP), which is similar to prepayment risk found in mortgage-backed securities. Investors are well compensated for this risk because of the unique protections in municipal housing mortgages, which include strong mortgage loan characteristics, excellent historical loan performance, flexible yet strong bond structures and active management of delinquent SF and MF mortgage loans. Moreover, the major difference between ERP risk and prepayment risk is that the housing financing agencies that manage the SF and MF housing programs also own and service their mortgages. This means that a housing finance agency is the first line of defense against unexpected prepayments. Supply of new housing revenue bonds could cause technical weakness in the sector if interest rates rise at a rapid pace, but credit quality in the sector is expected to remain stable, with more upside potential versus downside risks. Lastly, the sector is still cheap relative to other sectors of the municipal market. SNWAM is currently overweight the municipal housing revenue sector.
Sources: SNWAM Research