January 7, 2019
Since the last ARMs update, yield spreads on hybrid ARMs have widened 1 to 11 basis point (see chart below). The widest spreads can be found in G2 5/1s with 2/2/6 cap structures (11 bps) and FNMA/FHLMC 5/1s with 5/2/5 cap structures (10 bps).
Fannie Mae and Freddie Mac 5/1s have widened 25 basis points since the start of 2018. Much of the spread widening can be attributed to lower tail valuations because of fast prepayment speeds at the first reset date, as well as fixed-rate mortgage spread widening. However, this trend could reverse as front-end rates move lower. As of today, 12-month LIBOR is down 18 basis points from its peak of 3.14 on November 9th. Furthermore, new issue ARM borrowers are paying considerably higher weighted average coupons than several years ago (see chart below), and as a result will face less of a rate shock at the first reset date than today’s pre-reset borrowers are facing.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- New issue Freddie Mac 7/1 Giants with ~80 months-to-reset traded at a slight premium.
- New issue Fannie Mae 10/1s with coupons ~ 3.7% to 3.9% traded at a moderate premium.
- New issue Ginnie Mae II 5/1s with ~ 3% coupons and reset dates between 52 – 58 months-to-rest traded near par. Any steepening in the yield curve will add upside to the 5/1 sector as tail values appreciate.
The following chart reflects the two-week change in LIBOR option-adjusted spreads for ARMs. With the exception of some short-reset bonds, OAS widened for GNMA, FNMA, and FHLMC.
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP