Actionable Alternatives: Residential Credit

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Text on screen: Actionable Alternatives Residential Credit

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Jason Steiner: Residential mortgage credit is the largest part of the asset-based finance market, comprising over $13.8 trillion in the US. 

Text on screen: Jason Steiner, Portfolio Manager, Residential Credit

This market is an important component of many of our private funds, and generally includes any residential mortgage loans that are not guaranteed by the government.

We think the housing market is attractive today, and fundamentally different than it was in 2008.

FULL PAGE GRAPHIC: Housing Surplus/Deficit. The bar chart measures U.S. housing supply in thousands from 2008 to 2024. There was a supply surplus from 2008 to around 2014, although that surplus significantly dwindled starting in 2012, 2013 and 2014, leading to a supply shortage starting around 2015. Housing undersupply became more pronounced from 2015 through 2024. Data as of 31 December 2024.

Despite elevated mortgage rates, the residential mortgage market is supported by a structural undersupply of housing. New construction has trended down, and existing home sales are tempered by homeowners locked into low, fixed mortgage rates.

FULL PAGE GRAPHIC: Homeowner Equity. The chart measures U.S. Home Equity as a percentage of Home Value from 2007 to February 2025. It shows a peak of 25% in 2007, prior to the 2008 Global Financial Crisis, followed by a post-GFC low of approximately -8% to -10% from around 2009-2012. From around 2013, home equity as a share of home value showed a sustained and significant increase to a little over 50% as of February 2024.

Borrower credit quality for the current stock of mortgages is robust, and is supported by strong home price appreciation, with homeowner’s equity reaching its highest in history.

Plus, we’ve witnessed a steady decline in implied Loan-to-value ratios and default rates since their peak in 2008, reflecting a tightening of lending standards.

Together, these factors support what we believe is an attractive opportunity set for residential mortgages.

Images on screen: Residential neighborhoods in the seventies

PIMCO has been investing in the mortgage markets since the firm’s inception in 1971.

Our experience in analyzing residential loans, combined with the strong datasets and analytical capabilities we've developed over the years, positions us uniquely in the market.

For example, we can utilize proprietary analytics tools that assign individual zip codes a score from 0 to 100, which captures key economic and housing metrics such as home prices, median income, and delinquency rates across both the US and Europe.

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Additionally, our established relationships with originators and our disciplined approach to underwriting enable us to pursue more favorable terms

for our investors.

Text on screen: Michael Chiao, Portfolio Manager, Residential Credit

Michael Chiao: Today, we’re diving into two areas of residential credit where we see opportunity: Non-Qualified Mortgages and Fix-and-Flip Loans.

Let’s start with Non-QM Mortgages. These loans cater to a variety of borrowers, including self-employed individuals, foreign nationals, and property investors. To compensate for the lack of government guarantee, non-QM loans often incorporate increased structural protections to offset any possibility of default, helping build resilient credit profiles in the process.

FULL PAGE GRAPHIC: FICO score distribution of Non-QM borrowers. The bar chart shows the FICO scores of non-qualified mortgage borrowers as of February 2024. The first bar from the left shows 10% of Non-QM borrowers with scores equal to or less than 680. The second bar shows 9% of borrowers with scores of 681-700. The third bar shows 13% of borrowers with scores of 701 to 720. The fourth bar shows 15% of borrowers with scores of 721 to 740, and the fifth bar shows 53% of borrowers with scores greater than 740.

In fact, we’ve seen an increase in credit quality among non-QM borrowers in recent years, with over half non QM collateral having credit scores of over 740.

B-roll: Home renovation

Now let’s look at Fix-and-Flip Loans, also known as Residential Transitional Loans are short-term loans designed for real estate investors looking to purchase renovate and sell, often within 12 to 24 months.

Fix-and-flip loans are typically secured by the property itself and can cover a range of renovations, from cosmetic updates to major overhauls.

The older age of housing inventory, which now has a median age of over 40 years, and the lack of new housing supply relative to new household formation, increases the demand for remodeled homes.

Across residential investments, we source opportunities through bank asset sales, as well as forward flow arrangements.

For bank asset sales, we’ve participated in large-scale portfolio sales from banks exiting the mortgage business or rebalancing their portfolios. Our approach begins with a bottoms-up analysis of data and analytics – assessing and stratifying the entire pool across mortgage type, property type, coupon, and geography. We organize the collateral pool based on different criteria and look for strong credit features.

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Our goal is to underwrite and acquiring assets with attractive risk return profiles. We also participate in the forward flow purchase of residential loans.

Even though loan pools are smaller, we apply the same, rigorous loan-level underwriting methodology for each pool.

As we navigate the evolving landscape of residential credit, we believe our focus on Non-QM and Fix-and-Flip positions us to capitalize on unique opportunities that arise from current market dynamics.

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Disclosure

This material (the “Material”) is being provided for informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy interests in a fund or any other PIMCO trading strategy or investment product.

The investment strategies discussed herein are speculative and involve a high degree of risk, including a loss of some or all capital. Investments in any asset classes described herein may be volatile, and investors should have the financial ability and be willing to accept such risks.

Asset-backed securities are highly complex instruments that may be sensitive to changes in interest rates and subject to early repayment risk. Structured products such as collateralized debt obligations are also highly complex instruments, typically involving a high degree of risk including default, liquidity, management, volatility interest rate and credit risk; use of these instruments may involve derivative instruments that could lose more than the principal amount invested. Private credit involves an investment in non-publically traded securities which may be subject to illiquidity risk. Portfolios that invest in private credit may be leveraged and may engage in speculative investment practices that increase the risk of investment loss. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

Certain information contained herein concerning economic trends and/or data is based on or derived from information provided by independent third-party sources.  PIMCO believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based.

This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.

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