April 30, 2018
Yield spreads between hybrid ARMs and Treasuries moved wider by 2 to 3 bps for the month of April. Weighted average coupons for new-issue pools increased 20 to 30 bps as the result of higher mortgage rates. Yields improved in April as well, leaving dollar prices only marginally higher month over month, despite the higher coupons. Given the tightening of fixed-rate MBS this month due to declining volatility and increased demand, the underperformance of ARMs has left new issue ARMs looking more attractive on a relative basis.
The origination cycle finished up last week, and volumes are expected to rebound from the recent lows seen in March ($991mm) to be more in line with late 2017 levels ($1.7bn to $2.0bn). Finally, there was a great deal of seasoned selling in the secondary market last week, with over $500mm of post-reset bonds exchanging hands. Most of this activity consisted of 5/1s with a weighted average loan age of 150 months or less.
Last week, activity was primarily focused on the following:
- GN 3/1 2.5s – Recently trading modestly under par with spreads widening due to the cap risk.
- 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.
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG