BofAML investor recommendation: decrease exposure to Fannie, Freddie

Bank of America Merrill Lynch recommends investors remain overweight in securitized-credit products while decreasing positions in agency mortgage-backed securities. Analysts said commercial mortgage-backed securities fared well the first week of 2011, as spreads on most CMBS have tightened enabling yields to drop in the face of rising Treasury yields. Because of the spread compression, BofAML expects economic growth and rising interest rates, with CMBS, non-agency residential MBS, and asset-backed securities to perform the best of all securitized products. Analysts said that assumption is strengthened by a “very supportive negative net supply story.” BofAML predicts a net supply of negative $320 billion across those three sectors this year. Analysts also expect the post-crisis yield convergence to end by June 30, or possibly even by the end of January “given the velocity of the first week spread move.” For Fannie Mae and Freddie Mac MBS, analysts continue to expect the sector to perform well but advise moving to a market weight from an overweight position, because Treasury yields moved sharply higher during the last two months of 2010 and “lower coupons traded with significantly longer durations” than analysts projected. “While carry will enhance returns relative to Treasuries, the expectation for a move higher in rate has implications for further extension of the market, although a good portion of that has already occurred,” BofAML said. Analysts think interest-only and inverse interest-only agency MBS should “benefit from a sharp slowdown in prepayments, attractive carry and, for the inverse sector, a Fed that will be on hold into late 2012.” Write to Jason Philyaw.