April 16, 2018
The rally in interest rates caused yield spreads between fixed-rate MBS and Treasuries to grind tighter by 2 to 3 bps on the week. For the past two weeks, hybrid ARMs have managed to lag the tightening experienced in fixed-rate MBS, making the sector more attractive on a relative basis.
Last week, activity was primarily focused on the following:
- GN 3/1 2.0s & 2.5s – Discounts (2.0s) and near par levels (2.5s)
- GN 5/1 2.5s – Investor demand for newer production 5/1 2.5’s has been relatively consistent with pricing below par.
- Short Resets – Lower premiums and the recent increase in LIBOR (see graph below) has contributed to higher yields on these pools. Investors are targeting conventional short resets (6- to 18-MTR with 5/2/5 cap structures) to potentially benefit from further increases in market interest rates. In many cases, current prepayment activity shows the temporarily elevated levels common to bonds nearing their initial reset dates. However, based on historical patterns, prepayment activity generally declines after the bonds reset. Using a vector to model this behavior shows that seasoned short resets can compare favorably to other adjustable rate alternatives.
Metrics for some commonly traded structures are below:
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG