Deer Park Road Management is preparing to launch a closed-end fund that will invest $2.5 billion investment in non-agency residential mortgage-backed securities (RMBS), the company announced, to address reduced investor participation in the sector.

The Deer Park Mortgage Opportunity Fund II, or MOF II, will launch in January 2027 and begin investing as opportunities emerge that meet their underwriting criteria.

MOF II addresses RMBS situations where "complexity, liquidity constraints and uncertainty around repayment timing can narrow the buyer base," according to sources familiar with the situation.

Elevated interest rate volatility and increased pressure on non-agency RMBS valuations have also presented challenges to some investors, the company explained.

Timing is another driving factor for Deer Park Road Management. The fund's predecessor, MOF I, will reach the end of its investment period in June 2027. During its three- and a half-year run, MOF I received $168 million in capital commitments, the company said.

The valuation story

In recent RMBS research, Deutsche Bank concurred with Deer Park Road's view on valuations, noting that non-residual yields on non-qualified mortgage bonds are being squeezed by the higher bond funding costs and have not been fully offset by higher mortgage rates.

"Lower excess spread in deals should mean slightly higher credit enhancement and increases [in] interest shortfall risk," Deutsche Bank analysts wrote.

Despite valuations being put under pressure, Deer Park Road Management said collateral fundamentals in some legacy securities is strong, making longer-term investor commitments, in the right security with the right execution, worthwhile.

For certain non-agency RMBS higher rates, slower expected repayments, and wider mortgage spreads have squeezed valuations, even in cases where borrower credit is supported due to deleveraging, accumulated homeowner equity and structural credit protection, Deer Park Road said.

""We believe these securities can benefit from that disconnect by acquiring them at discounted prices and holding them as cash flows are realized," sources said. "MOF II's closed-end structure aligns the investment horizon with that process."

Sustained investor confidence

Deal sizes for new non-QM RMBS originations is growing, in another sign of confidence in the sector. New transactions with RMBS volumes of $1 billion or more are hitting the market again, and average deal sizes are approaching $500 million, Deutsche Bank Research said.

The bank also noted that average deal sizes for home equity line-of-credit (HELOC) and closed-end second (CES) deals is stable, but the largest deals are seeing increases in how much they sell to investors.

Some areas of non-agency RMBS are cooling, though. Single-family rental outstandings declined to $4 billion, from $58 billion in 2024.

"Build-to-rent is the clearest path for a recovery in SFR issuance, but higher construction costs and bond funding costs stand in the way," Deutsche Bank said.