U.S. Residential Mortgage-Backed Securities

What is RMBS?

A residential mortgage-backed security is a bond backed by a pool of home loans. Thousands of mortgages are pooled together, and the principal and interest those borrowers pay each month are passed through to bondholders.

These consistent monthly payments are one of the most distinct characteristics of the RMBS asset class. RMBS is one of the only asset classes that becomes safer as it approaches maturity. As borrowers make their monthly payments, the loans de-risk through principal paydown and growing home equity.

In contrast, traditional fixed-income vehicles, such as corporate or municipal bonds, require issuers to pay off their full debt at maturity, creating what’s known as balloon or refinance risk.

The unique structure of RMBS provides flexibility in managing interest rate, credit, and reinvestment risk within fixed income portfolios. The return of cash flows can continually be redeployed, enabling superior compounding and income generation over time.

Why do the largest active fixed income managers own so much of it?

Looking at the 40 largest active fixed income mutual funds by AUM, which in aggregate hold more than $1.6 trillion in assets, the average allocation to MBS across those funds is over 46%. That’s nearly 20 percentage points higher than their next-largest exposure (corporates, at 27%).

If you wanted to know where the smartest fixed income money sits, it is not in corporates, and it is not in Treasuries. It is, quietly, in mortgages. — Skyler Weinand, CIO, Regan Capital

What explains the allocation difference? Three reasons: structural amortization that reduces risk over time, a wide menu of duration and credit profiles that lets a manager tailor exposure precisely, and a meaningfully better risk-adjusted yield than corporate credit at current spreads. The market’s complexity is precisely why the opportunity persists and is why it requires experienced managers who understand how to balance risk and reward across constantly evolving market environments.

Investing in RMBS: Balancing Risk & Reward

Top fixed income managers have been capitalizing on the distinct advantages of the RMBS market for decades. However, investors overall remain largely underexposed to the sector relative to corporates and Treasuries. Effectively adding RMBS to a fixed income portfolio requires experienced managers who understand how to balance various risk dimensions to achieve desired client outcomes. Regan Capital uses several tools and frameworks to measure risk.

Duration Risk & Yielduration

Duration, measured in years, captures a bond’s sensitivity to changes in interest rates. The higher the duration, the greater the price impact from a given move in yields — meaning bonds experience larger declines when rates rise and larger gains when rates fall. For nearly four decades, bond investors benefited from maintaining longer-duration exposure as a persistent decline in interest rates provided a powerful tailwind for bond prices and total returns. More recently, however, one of the fastest rate-hiking cycles in the modern bond market reversed that dynamic, exposing just how much duration risk had quietly accumulated in fixed income portfolios. That shift raises a critical question for investors today: are you being adequately compensated for the duration risk you’re carrying?

It is a careful balance between taking on duration in exchange for yield. To conceptualize and measure this trade-off, Regan Capital uses a measure we have termed “Yielduration”: yield-to-maturity divided by duration. A Yielduration of 1.0 means an investor is getting one unit of yield for taking on one unit of interest rate risk, or in other words, a 100 basis point cushion before rising rates wipe out the annual yield. We view 1.0 as a reasonable floor; at anything lower, investors are likely not being adequately compensated for the risk they are carrying.

Yielduration has increased recently but remains historically low. RMBS, with its amortizing cash flows and flexible duration profile, offers a more favorable risk-reward trade-off in this environment.

Convexity

While duration measures a bond’s sensitivity to interest rate changes at a given moment, convexity captures how that sensitivity behaves as rates move, because a bond’s price does not move in a straight line. Convexity accounts for that curve, revealing whether a bond will perform better or worse than duration alone would predict.

For mortgage bonds, the dominant driver of convexity is the borrower's option to prepay. When a bond trades at or above par, the borrower's prepayment option works against the investor. If rates fall, the borrower refinances, returning principal at par when you'd prefer to keep earning an above-market coupon. If rates rise, the borrower doesn't refinance, extending your duration exactly when you don't want it. This is negative convexity.

When a bond trades at a meaningful discount to par, which describes most of the seasoned RMBS universe today, the math flips entirely. Prepayments become beneficial: principal returns at par while you paid, say, 75 cents on the dollar. Rates rise and the bond falls less than duration would predict. Rates fall and it appreciates more. This positive convexity is one of the most attractive features of today’s discount-price RMBS market.

Agency RMBS

The U.S. mortgage securities market began in 1968 with the founding of Ginnie Mae. Today, of the $11.8 trillion outstanding RMBS market, roughly $9.23 trillion is Agency — bonds whose timely payment of principal and interest is guaranteed by a government-owned agency (Ginnie Mae) or government-sponsored entity (Fannie Mae or Freddie Mac).

Agency RMBS carries effectively zero credit risk. Instead, investors are compensated for interest rate risk, prepayment risk, and the analytical complexity associated with forecasting the timing and amount of mortgage cash flows.

Managing that uncertainty has been one of the central challenges and innovations of the agency mortgage market. The first agency CMOs in the 1980s introduced “time-tranching”, splitting cash flows into tranches with different priority of repayment. This concept enabled investors with different needs to participate on their own terms, such that a bank seeking to match short-duration liabilities could buy the front-end tranche while an insurance company seeking long-dated income could buy the back-end. This single innovation that allowed investors to choose the cash flow profile they want, turned the mortgage market into the multi-trillion-dollar institution it is today.

Non-Agency RMBS

Non-agency RMBS are bonds backed by loans that don’t conform to agency guidelines. These are not necessarily lower-quality loans, but loans the agencies cannot or do not buy: jumbo mortgages above the conforming limit, loans to self-employed borrowers, investor properties, or borrowers whose income documentation doesn’t fit the Qualified Mortgage framework.

Non-agency RMBS are the original form of private credit. Before the FHA was established in 1934, virtually all mortgage lending in the United States was private. Mortgages had loan-to-values rarely exceeding 50%, terms of 5–10 years and were funded by savings cooperatives with no government guarantee.

Credit Risk

Unlike agency bonds, whose credit is guaranteed by the U.S. government, non-agency RMBS carry a credit risk component that investors must evaluate and price. Credit risk is the possibility that a borrower defaults on their loan obligation.

The primary mechanism for managing credit risk in non-agency RMBS is the senior-subordinated structure. Under this framework, losses are absorbed from the bottom up, while principal is distributed from the top down. As a result, investors can strategically position themselves across the capital structure, choosing how much credit risk to assume in exchange for higher potential yields.

For a pool with average credit quality of, say, low investment grade, this structure can produce a thick AAA-rated bond that would absorb losses only if cumulative pool defaults exceeded 40%.

Subsectors of Non-Agency RMBS

The non-agency RMBS market is not monolithic. Rather, it consists of several distinct subsectors, each with its own risk profile, investor base, and purpose.

• Prime Jumbo 2.0Post-crisis prime mortgages originated above the conforming loan limit ($806,500 in 2025). Borrowers typically have high FICO scores and fully documented income, while deal structures feature materially stronger protections than legacy vintages, including higher subordination levels and more stringent covenants.
• Non-QMMortgages extended to borrowers who fall outside the Qualified Mortgage framework, including self-employed borrowers without traditional W-2 income, foreign nationals, investment property owners, or borrowers with substantial assets but limited current income. These are not subprime borrowers; they simply do not meet QM standards. Non-QM remains the fastest-growing segment of the new-issue non-agency market.
• Credit Risk Transfer (CRT)Since 2013, Fannie Mae and Freddie Mac have transferred a portion of the credit risk on agency-conforming loans to private investors through senior-subordinated structures. The agencies retain exposure across the capital structure, helping align their interests with those of the bondholders. More than $3.4 trillion of loan balances have been referenced through CRT transactions to date.
• NPL / RPLNon-performing and re-performing loans are often legacy pre-2008 mortgages purchased at significant discounts. Investors seek to extract value through loan modifications, liquidations, restructurings, or eventual resale. Transactions are typically structured with substantial subordinate exposure retained by the sponsor.
• Single-Family Rental (SFR)Established in 2013, this subsector securitizes loans backed by institutional single-family rental portfolios. Cash flows are generated by rental income rather than borrower mortgage payments. As a result, these securities are often evaluated using commercial real estate metrics such as debt service coverage, vacancy rates, and rental yields, despite being backed by residential properties.
• Second Mortgages / Home EquityLoans secured by subordinated interests in residential properties, including second mortgages, HELOCs, and Home Equity Investments. Because these claims sit behind the first mortgage in the repayment hierarchy, investors are compensated with higher yields for assuming the additional subordination risk.

Addressing MBS Misconceptions

The 2008 financial crisis is often associated with the U.S. mortgage market, and that perception has shaped how many investors view the asset class today. Understanding what caused the crisis, and what has structurally changed, is essential to evaluating RMBS today.

The crisis was rooted in weak lending standards. Loans were originated with limited income verification, then packaged into deals where subordination levels were calibrated to a housing environment that had never been stress-tested. When home prices declined in 2007, those protections proved inadequate.

Three structural changes after 2008 fundamentally altered the risk profile of the asset class:

• Underwriting Was RebuiltThe 2010 Dodd-Frank Ability-to-Repay standards and the 2014 Qualified Mortgage rules eliminated negative amortization, balloon payments, interest-only periods, and excessive fees. Income, employment, and asset verification became mandatory.
• Subordination Levels RoseSenior tranches in post-2008 non-agency deals are protected by substantially thicker subordinated layers than those in legacy deals. Post-crisis bondholders are significantly better insulated from credit losses.
• Skin in the Game Became RequiredDodd-Frank Section 941 requires issuers to retain 5% of every deal. In CRT, the agencies retain a portion of every tranche, ensuring interests are aligned.

The post-crisis mortgage market, particularly non-agency, operates under an entirely different set of underwriting and structural standards. We approach legacy and new-issue product as distinct opportunities, with different risks, different analytical frameworks, and different roles in a portfolio.

The Opportunity Today

Today, the mortgage market presents an unusual setup. Rate volatility remains elevated and mortgage spreads are currently wider than investment-grade corporate credit spreads. As of June 2026, the current-coupon agency MBS basis is roughly 107 basis points, while the Bloomberg U.S. Corporate Average trades at an option-adjusted spread of about 72 basis points. Mortgages are paying investors approximately 35 basis points more than corporate bonds.

That relationship is historically backwards. Over the past two decades, mortgages have typically traded tighter than corporates — as you would expect from bonds backed by the U.S. government. The mortgage basis has exceeded corporate OAS only about a third of the time, and almost always during brief moments of stress.

What makes today different is persistence. For more than 30 consecutive months dating back to early 2024, the mortgage basis has held above corporate OAS. This is not a momentary spike; it is a sustained regime in which the market is charging investors more to own a government-guaranteed cash flow than unsecured corporate credit.

Corporate spreads are near the richest levels of the last 20 years, leaving investors paid very little to take on default and downgrade risk. Agency MBS, by contrast, are cheap for reasons that have nothing to do with credit. Their basis is wide because of the convexity and rate-volatility dynamics discussed earlier. Prepayment uncertainty is being driven by where rates sit and how much they move, not borrower solvency. The result: a U.S. government-guaranteed cash flow out-yields unsecured corporate debt by roughly 35 basis points, a premium that tends to compress as rate volatility normalizes.

This dislocation has persisted long enough to give investors time to act thoughtfully rather than chase a fleeting opportunity. Capturing it requires separating cheap convexity from genuine risk and expressing the view in the right part of the capital structure.