January 22, 2019
Yield spreads on hybrid ARMs to Treasuries tightened approximately 1 to 2 basis points as the broader bond market experienced a sell-off. For the week, the 10-year Treasury increased 9 bps from 2.70% to 2.79%, the highest yield since December 26th.
The ARM origination cycle continued last week, with 716.5mm in new issue ARM selling primarily from Fannie Mae (395.7mm). Supply was focused in Fannie Mae 7/1s (212.9mm), Ginnie Mae 5/1s (164.2mm), and Fannie Mae 10/1s (98.7mm). Short-reset 3/1 issuance has been minimal recently with monthly issuance levels not exceeding 100mm since May 2018.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- Seasoned, current reset Freddie 5/1s with ~ 4.2% gross weighted average coupons traded at a moderate premium (102+).
- New issue Ginnie 5/1 3.5s with ~ 5 years to the reset and price volatility less than 10% +300 traded near the 101 handle.
If the yield curve continues to flatten, 5/1 hybrid ARMs should outperform most similar-duration fixed-rate alternatives. They also perform well if the curve holds onto its current slope or steepens modestly. Investors should consider cap structures as well. Most conventional hybrids have a 2/2/5 or a 5/2/5 cap versus a 1/1/5 found on most GNMA structures. This more generous cap structure allows more coupon movement, something that will be more attractive if rates rise.
The following chart reflects the week over week change in LIBOR option-adjusted spreads for ARMs. With the exception of some short-reset conventional bonds, OAS widened for GNMA, FNMA, and FHLMC.
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP