ARM Update

August 12, 2019

Demand for new-issue hybrid ARMs slowed, which resulted in yield spreads to Treasurys widening last week.  A combination of US China trade tensions, Treasury auctions, dovish comments at various central banks, and political unrest across the world promoted the flight-to-safety narrative.  The broader bond market moved up in price, sending yields lower across the curve.  We see relative value in longer-reset 10/1s as they remain approximately 40 bps wider compared to levels in early March.

The following chart reflects the week over week change in Z-spreads for ARMs.  Z-spreads widened for shorter-reset Ginnies and conventionals but tightened for longer-reset products.

The ARM origination cycle was light last week, with 120.3mm in new issue ARM selling split amongst Fannie Mae (74.1mm), Freddie Mac (22mm), and Ginnie Mae (24.2mm).  Supply was focused in Fannie Mae 7/1s (51.3mm) and Ginnie Mae 5/1s (22.6mm).  Freddie Mac also contributed to gross issuance with 13.1mm in shorter-reset 5/1s.  ARM gross issuance remains at multi-year lows as it came under 1 billion for the third consecutive month in July.

Hybrid ARM issuance remains quite low.  As of August, hybrid ARM issuance represents ~ 0.42% of overall MBS issuance.  Nevertheless, issuance volumes have been at their highest levels in Ginnie Maes, followed by Fannie Maes and despite the meager volumes, hybrid ARM issuance as a percentage of overall MBS issuance trended higher last month versus May and June.

Prepayments continued their general year-to-date trend as July prepayments for hybrid ARMs increased.  August-released factors indicated that July ARM prepayments increased 4.23% to 15.38% for all three agencies.  In aggregate, Fannie ARM speeds increased 3.8 CPR to 28.5, Freddie rose 3.5 CPR to 27.1, and Ginnie increased 1.3 CPR to 32.

Shorter-reset LIBOR-based Fannie 3/1s increased 3.2 CPR to 24.3 and 5/1s increased 3.7 CPR to 32.7.  Longer-reset 7/1s increased 4.1 CPR to 29.5 and 10/1s increased 4.5 CPR to 21.1.  In the Ginnie sector, Treasury-based 3/1s, 5/1s, and 7/1s paid 31.3 CPR (+6.46%), 32.4 CPR (+2.86%), and 33.8 CPR (+17.77%), respectively.

Last week, ARM activity was spread across a variety of lists and primarily focused on the following:

On July 11th, 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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