ARM Update

January 6, 2020



Yield spreads between hybrid ARMs and Treasurys were unchanged last week, as the broader bond market moved up in price, sending yields lower across the curve.  Investors flocked to Treasurys in a flight-to-safety trade, shying away from risk assets, after recent developments in the Middle East.  ARMs outperformed mortgage-related sectors with 15- and 30-year fixed-rate mortgages widening 2 to 3 basis points on the week.

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 60 bp spread, almost 32 bps wider than they were in mid-February.  Longer-reset 7/1s and 10/1s have a 62 and 64 bp spread, respectively, approximately 24 and 14 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 made the ARM sector competitive to fixed rates.  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.



After weaker November issuance levels, new ARM issuance for December slightly rebounded totaling 741.7mm.  Supply was split amongst Fannie Mae (437.8mm), Freddie Mac (289.1mm), and Ginnie Mae (14.8mm).  Supply continues to be focuses focused in 7/1s (352.9mm) with 5/1s and 10/1s issued in amounts of 110.4mm and 278.4mm, respectively.  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 eighth consecutive month.



Hybrid ARM issuance remains quite low.  In 2019, 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 December, hybrid ARM issuance represented ~0.98% of overall MBS issuance.



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

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