In short: Agency MBS (Fannie/Freddie pools) offer extra yield with no credit risk — 4.3% annualized over three years, ~1.2 pp ahead of Treasurys — but the prepayment option is back: with 5%-plus loans now over 40% of balances, rising rates extend the bonds and hurt price while falling rates shorten them and force reinvestment lower. Harley Bassman: more yield than Treasurys, but you lose more when rates rise and make less when they fall; FHN Financial says the market is "very complacent" about faster speeds.
MBB is a fund that owns bundles of ordinary American home loans packaged into bonds by Fannie Mae and Freddie Mac. Because the government stands behind those agencies, you are not really worried about homeowners defaulting — and you still get paid more than on plain Treasury bonds: about 5.8% versus just under 5% on the 10-year, and over the past three years the fund beat a Treasury fund by roughly 1.2 percentage points a year.
The catch is that every homeowner holds a free option: they can pay the loan off early whenever they like, usually by refinancing when rates drop. That is bad for the bondholder in both directions. If rates fall, loans get paid off fast and you get your money back just when you can only reinvest it at lower rates. If rates rise, nobody refinances, the bond lasts longer than you expected, and its price falls harder than a normal bond's. The bond expert Harley Bassman sums it up: more yield than Treasurys, but you lose more when rates rise and make less when they fall. (Bond people call this "negative convexity".)
For the last few years that option barely mattered, because almost everyone had a 2–3% pandemic mortgage they would never refinance. The article's news is that this has changed: more than 40% of mortgage dollars now sit in loans at 5% or higher, which really could refinance if rates came down — for example after a downturn in the AI trade. And refinancing may happen faster than history suggests, because loans are bigger, borrowers have better credit, non-bank lenders chase refinancing volume, and AI could make the paperwork far quicker. So the yield is real, but a strategist at FHN Financial says the market is "very complacent" about the risk — a neutral, eyes-open mention rather than a buy call.
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