ARM Update

April 6, 2020



Last week, the Labor Department reported that the U.S. lost 701,000 jobs in March, which was the first decline in job creation in a decade.  The data comes after a separate report on Thursday showed a record 6.6 million Americans applied for unemployment benefits.  In a continuing trend, yield spreads on both Ginnies and conventionals tightened 5 basis points on the week.  The Fed has quickly become the main participant in the agency MBS market.  In doing so, it has created pockets of illiquidity and volatility, with performance differences emerging between MBS eligible for Fed purchases and securities that are not, even in instances where securities are similar.  On the week, 15- and 30-year fixed rate mortgages widened 10 and 16 basis points, respectively, and underperformed their adjustable-rate counterparts.

Since the rally at the end of 2018, ARM pricing spreads have widened significantly, reacting strongly to each move lower in rates.  For example, 5/1 ARMs have a 135 bp spread, almost 1115 bps wider than they were in early-December 2018.  Longer-reset 7/1s and 10/1s have a 145 and 150 bp spread, respectively, approximately 112 and 103 bps wider than levels in early-December 2018.  Certainly, the environment for ARMs has changed dramatically over the years with the flattening yield curve, but today’s spreads are well wider than those seen just one month ago.



Factors such as diminished liquidity, lack of index sponsorship, and the small market size have increased their spread concessions to fixed rates.  Spreads are wider by approximately 63 bps on 7/1s versus their 15-year fixed rate counterparts.  Overall, we continue to see relative value in 7/1s due to appealing yields, shorter durations, and less negative convexity than comparable coupon 15-year fixed rate MBS.  Investors concerned about potentially faster prepayments could focus on lower WAC new-issue pools or moderately seasoned paper.



Issuance levels to start the year continue to remain weak as new ARM issuance for March totaled 536.9mm.  Supply was split amongst Fannie Mae (373.9mm), Freddie Mac (154.8mm), and Ginnie Mae (8.2mm).  Supply continues to be focused in 7/1s (244.1mm) with 5/1s and 10/1s issued in amounts of 74.9mm and 217.9mm, respectively.  For the fourth straight month, no 3/1s were issued as this shorter product continues to be largely abandoned by lenders and the GSEs.  ARM gross issuance remains at multi-year lows as it came under 1 billion for the eleventh consecutive month.  Last year, the monthly net supply of ARMs ran at a negative $2-3 billion pace, while fixed rates grew at $20-30 billion each month.  As of March, hybrid ARM issuance represented ~ 0.70% of overall MBS issuance.



Last week, ARM activity was primarily focused on the following:


On November 15, 2019, the Alternative Reference Rates Committee (ARRC) released recommendations on contract fallback language to be used for new closed-end residential adjustable-rate mortgages (ARMs).  The recommended fallback language for each of these products is based on the following framework:


A recent Vining Sparks’s publication provides the latest developments and planning steps for the transition from LIBOR.


On July 11, 2019, the Alternative Reference Rates Committee (ARRC) released a white paper detailing how an average of the Secured Overnight Financing Rate (SOFR) can be used in newly issued ARMs in a structure that is comparable to today’s existing ARM loans.  The white paper shows how SOFR can be used to develop products that are built on a robust reference rate that is grounded in market transaction.  Here’s an overview of the ARRC’s proposed models of SOFR ARMs:



The desk continues to look to bid odd-lot positions for both conventionals and Ginnies 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.



Ricky Brillard, CPA

Senior Vice President, Investment Strategies

Vining Sparks IBG, LP

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