TSS Episode 137: Ken Shinoda on Mortgage Investing and the Housing Market

Ken Shinoda, who chairs DoubleLine’s Structured Products Committee and leads the firm’s non-Agency mortgage securities team, discusses his asset class and housing market outlook with Jeffrey Sherman and Samuel Lau on April 10.

Mr. Shinoda discusses his path in asset management, joking that early in his career “my MBA was the Global Financial Crisis,” and his roles at DoubleLine (2:05). He delves (3:47) into the evolution of residential mortgage-backed securities (RMBS), from an asset class in the 1970s and 1980s dominated by Agency RMBS, backed by the principal guarantee of the federal government, and then the growth in the non-Agency or private-label RMBS sector in the 2000s. He then (6:52) describes the roughly $650 billion private-label sector in greater detail and the reasons for investing in it, as opposed to investing in the $7 trillion Agency sector. In exchange for taking that credit risk, he notes, “you can get paid a significant spread over Agencies today. Sometimes it’s more, sometimes it’s less. We’ve found that mixing Agencies and non-Agencies together and weighting more toward credit when spreads are really wide, less toward credit when spreads are really tight. If you actively manage that mix between Agencies and non-Agencies, you’re actually able to generate a better risk-adjusted return through time relative to if you just hold the index.”

The discussion next turns to Mr. Shinoda’s outlook for the U.S. housing market (9:23). Of “the three biggest drivers of single-family home prices,” he notes (1) affordability has worsened due to higher mortgage rates and home prices. But the lack of (2) supply relative to (3) demand is “supportive of housing in the long run.” Home prices, he acknowledges “are down about 5% from the peak” in 2022. “Could we go down a little bit more? Of course. I think there’s probably still some downside pressure nationwide, but you’ve already started seeing some metros flatline, stop going down. On the East Coast especially, there’s places that are still going up in price, if you can believe it. Florida, Buffalo. There’s just a wave of people moving to that southeast area in Florida especially, that is propping up home prices, even though mortgage rates are high.”

In a context of growing signs of economic weakness and recent turbulence in regional banking, Mr. Lau asks Mr. Shinoda to explain his view that the housing market, while undergoing a correction, will avoid a crash of the magnitude that occurred in the Great Financial Crisis (GFC). Noting the GFC was centered around excesses in mortgage underwriting, Mr. Shinoda says (12:51), “the market is now so much safer” because in the wake of that crisis, “there’s a lot more strict rules and regulations around mortgage underwriting” and the fact that borrowers today have significant equity in their homes.

Mr. Shinoda also discusses the post-GFC regulatory landscape for non-Agency RMBS (14:05). He notes for example that risk-retention rules under Dodd Frank require issuers of certain mortgage bonds to retain 5% of the bonds for up to five years. In contrast, before the GFC, investment banks could buy loans from originators, securitize them into RMBS and sell all the exposure into the primary market. Today “through regulation you’ve got skin in the game from the issuers,” he says. “Most people who are doing these deals are keeping the equity, and they don’t want to take losses. I think that’s a second component that makes these bonds safer. Lastly, the rating agencies, the ones that got it so wrong during the GFC that had all these bonds get downgraded, they’ve gotten much stricter on what they require to call a bond investment grade, especially to call a bond AAA.” 

In response to a question from Mr. Sherman (21:07), Mr. Shinoda discusses the mortgage bonds held by U.S. banks. Mr. Shinoda notes that banks tend to hold Agency RMBS as well as Treasuries rather than non-Agency securities on their books. In bank takeovers by the Federal Deposit Insurance Corp., he expects the FDIC to conduct orderly asset sales. “Fire-selling mortgage-backed securities is not going to solve the issue that plagues not just SVB (Silicon Valley Bank) but many of the other banks. It would just create more stress in the system.”

Next, Mr. Shinoda walks through (24:43) his team’s processes, methods and data for evaluating the credit and prepayment risk of loan pools collateralizing non-Agency RMBS and how they run different payment and default scenarios against the capital structures of the bonds to see if the bonds will take losses under those scenarios.

Given that the Fed was a larger buyer of Agency RMBS during its quantitative easing campaign, Mr. Sherman asks (28:19) for the impact to that fixed income sector as the Fed seeks to reduce its balance sheet. Mr. Shinoda notes that the bulk of buying of these securities by the Fed and banks such as SVB occurred when rates were much lower than today’s. As a result, much of the Agency RMBS held by those institutions have coupons of 2% and 2.5%, bonds which also are subject to heavy demand by index investing for these securities. He notes that selling of these bonds by the Fed would not “do anything to fight inflation.” With mortgage spreads already wide, “pushing mortgage spreads out another marginal, let’s call it 20-50 basis points, doesn’t really help them fight inflation. That’s why they’re just focusing on the fed funds rate.” In the wake of the surge in yields off the lows of 2020, he adds that selling Agency RMBS “would lock in losses on the balance sheet.”