April 8, 2019
March was a challenging month for hybrid ARMs, with spreads widening approximately 10 or 11 basis points. The widening was driven by the reduced demand at higher dollar prices into the rally. Recently, we’ve seen buyers emerge due to the wider spreads and as rates have receded from the lows. Overall, hybrid ARM spreads remain approximately 22 to 35 basis points wider than March 2018, and last month’s poor performance has created an attractive entry point for relative-value players. ARMs have been unaffected by the increase in WAC/coupon spreads this year, and the continued decrease in 12-month LIBOR should reduce rate shock for post-reset borrowers, ultimately benefiting tail values.
The ARM origination cycle continued last week, with 206.4mm in new issue ARM selling split amongst Fannie Mae (59.1mm), Freddie Mac (79.4mm), and Ginnie Mae (67.9mm). Supply was focused in Freddie Mac 10/1s (75.5mm) and Ginnie Mae 5/1s (67mm). Fannie Mae also contributed to gross issuance with 20mm in 5/1s, 19.8mm in 7/1s, and 19.3mm in 10/1s. Last month, ARM issuance levels increased to 1.5 billion, reversing the downward trend seen between January and February.
For the second consecutive month, prepayments for conventional hybrid ARMs increased. April-released factors indicated that March ARM prepayments increased 9.05% to 10.99% for all three agencies. In aggregate, Fannie ARM speeds increased 2.1 CPR to 21.2, Freddie rose 2.5 CPR to 19.8, and Ginnie increased 1.9 CPR to 22.9.
Shorter-reset LIBOR-based Fannie 3/1s increased 0.5 CPR to 22.6 and 5/1s increased 2.8 CPR to 26.8. Longer-reset 7/1s increased 2.3 CPR to 20.1 and 10/1s increased 0.3 CPR to 11.2. In the Ginnie sector, Treasury-based 3/1s, 5/1s, and 7/1s paid 26.3 CPR (+9.13%), 20.1 CPR (+8.65%), and 31.7 CPR (+69.52%), respectively.
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+).
- Seasoned Fannie Mega 7/1s with lower coupons (2.8%+) and ~ 66 months to reset traded at a slight premium. There has been demand in 7/1 ARMs recently after the double-digit widening in spreads that occurred into the rate rally.
- Seasoned Fannie Mega 10/1s with ~ 3.4% coupons and ~ 110 months to reset traded at a moderate premium. The seasoning improves convexity, a trait which has increased in importance with rates near the recent lows.
The following chart reflects the week-over-week change in Z-spreads for ARMs. Z-spreads tightened for GNMA, FNMA and FHLMC products.
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP