Benefiting from Extension Risk in the Non-Agency Market

Abstract

Two trends in the mortgage market are quite apparent: the time spent in the liquidation pipeline is increasing and modification activity is increasing. This article reviews these trends and then focuses on three types of bonds that are attractively priced in the base case and benefit from these trends: 1) front pay tranches of subprime deals, where the deal goes pro rata when the subs are extinguished; 2) selective mezzanine tranches of subprime deals that are trading as credit IOs; and 3) non-agency inverse IOs.