ARM Update

December 9, 2019

There was increased demand for new-issue hybrid ARMs last week, which caused yield spreads to Treasurys to tighten a basis point.  ARM spreads tightened 1 to 2 basis points month-over-month, outperforming fixed-rate MBS, which widened 2 to 3 basis points.  Week over week, Z-spreads were mixed for GNMA, FNMA, and FHLMC products (see table below).  The broader bond market moved down in price, sending domestic yields higher on strong jobs data and conflicting trade headlines.

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 61 bp spread, almost 33 bps wider than they were in mid-February.  Longer-reset 7/1s and 10/1s have a 66 and 75 bp spread, respectively, approximately 28 and 25 bps wider than levels in mid-February.  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 during 2017 at lower dollar prices.

Factors such as diminished liquidity, lack of index sponsorship, and the small market size have increased their spread concessions to fixed rates.  Despite the convergence, spreads are wider 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.

The ARM origination cycle was light last week, with 73.7mm in new-issue ARM selling split amongst Fannie Mae (57mm), Freddie Mac (10mm), and Ginnie Mae (6.7mm).  Supply continues to be focused in 7/1s with Fannie Mae issuing 30.2mm.  Fannie Mae also contributed to longer-reset 10/1 issuance with 26.8mm.  3/1 ARM products continue 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 seventh consecutive month.

Hybrid ARM issuance remains quite low.  The monthly net supply of ARMs continues to run at a negative $2-3 billion pace, while fixed rates are expected to grow at $20-30 billion each month for the rest of the year.  As of December, hybrid ARM issuance represents ~ 0.35% of overall MBS issuance.

Prepayments reversed course as November prepayments for hybrid ARMs decreased.  December-released factors indicated that November ARM prepayments decreased 8.02% to 16.45% for all three agencies.  In aggregate, Fannie ARM speeds decreased 5 CPR to 25.4, Freddie dropped 3.5 CPR to 24.6, and Ginnie Mae fell 2.6 CPR to 29.8.

Shorter-reset LIBOR-based Fannie 3/1s decreased 2.5 CPR to 20.5 and 5/1s declined 4.5 CPR to 27.6.  Longer-reset 7/1s fell 5.7 CPR to 26.5 and 10/1s dropped 3.4 CPR to 23.3.  In the Ginnie sector, Treasury-based 3/1s, 5/1s, and 7/1s paid 29 CPR (-8.81%), 30.5 CPR (-7.58%), and 19.7 CPR (+121.35%), 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 ARRCs 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

The information included herein has been obtained from sources deemed reliable, but it is not in any way guaranteed, and it, together with any opinions expressed, is subject to change at any time. Any and all details offered in this publication are preliminary and are therefore subject to change at any time. This has been prepared for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs of any individual or institution. This information is, by its very nature, incomplete and specifically lacks information critical to making final investment decisions. Investors should seek financial advice as to the appropriateness of investing in any securities or investment strategies mentioned or recommended. The accuracy of the financial projections is dependent on the occurrence of future events which cannot be assured; therefore, the actual results achieved during the projection period may vary from the projections. The firm may have positions, long or short, in any or all securities mentioned. Member FINRA/SIPC.
Copyright © 2021
This is a publication of Vining-Sparks IBG, L.P.
775 Ridge Lake Blvd., Memphis, TN 38120