April 22, 2019
Yield spreads between hybrid ARMs and Treasuries were unchanged last week, as the broader bond market moved up in price, sending yields slightly lower across the curve. ARMs outperformed their fixed-rate counterparts, with yield spreads widening on this product approximately 3 to 5 basis points for the week. We continue to see relative value in ARMs as they remain 10 to 25 bps wider compared to levels in early December.
The ARM origination cycle continued last week, with 1.07 billion in new issue ARM selling split amongst Freddie Mac (895mm), Fannie Mae (141mm), and Ginnie Mae (36mm). Supply was focused in Freddie Mac 7/1s (536mm) and Freddie Mac 5/1s (293mm). Fannie Mae also contributed to 7/1 and longer-reset 10/1 issuance with 66mm and 41mm, respectively. With 1.44 billion originated month-to-date, April issuance exceeds levels from 9 of the previous 12 months with 7 business days remaining in the month.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- New issue Fannie Mega 5/1s with higher coupons (3.5%+) and less than 5-year resets traded at a moderate premium ($102+).
- New issue Fannie Mega 10/1s with higher coupons (3.4%+) and ~ 9-year resets traded at a moderate premium ($102+).
In new issue space, 10/1 hybrids are attractively priced with spreads in the high 50s. 10/1 borrowers are paying ~25 bps higher in rate compared to a 7/1 borrower for the 3 extra years of fixed rate period, and as a result these borrowers likely intend to be in their loans for longer than 5/1 or 7/1 borrowers. This was reflected in March 2019 prepayment speeds:
5/1 Hybrid ARM 26.8 CPR
7/1 Hybrid ARM 20.1 CPR
10/1 Hybrid ARM 11.2 CPR
As you can see, 10/1s have paid slower and they offer the widest spread with spreads in the high 50s (~27 bps wider than a year ago).
The desk continues to look to bid odd-lot positions for clean-up. The disposition of odd-lot positions can result in enhanced transactional liquidity and higher earnings. Also, this is an opportunistic time to consider eliminating smaller line items that are subject to standard safekeeping and accounting fees that are more palatable for larger block sizes.
The following chart reflects the week over week change in Z-spreads for ARMs. With a couple of exceptions, Z-spreads tightened for GNMA, FNMA, and FHLMC products.
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP