July 8, 2019
Z-spreads for conventional hybrid ARMs were 4 to 9 bps tighter on the week, compared to a modest tightening for fixed-rate MBS. The broader bond market moved down in price, sending yields higher across the curve during last week’s holiday-induced slowdown. ARMs outperformed their fixed-rate MBS counterparts, with yield spreads tightening 4 bps on the 15-year fixed and 3 bps on the 30-year fixed. Despite ARM spreads tightening last week, we continue to see relative value in ARMs as they remain 32 to 50 bps wider compared to levels in early December.
The ARM origination cycle continued last week, with 126mm in new issue ARM selling split amongst Fannie Mae (65.7mm), Freddie Mac (11.6mm), and Ginnie Mae (48.7mm). Supply was focused in Ginnie Mae 5/1s (46.3mm) and Fannie Mae 7/1s (50.2mm). Fannie Mae also contributed to gross issuance with 14.3mm in 5/1s. June’s ARM issuance at 642.8mm was slightly higher than May’s originations (631.4mm), but issuance remains at multiyear lows.
June prepayments for hybrid ARMs decreased for Fannie Mae and Freddie Mac, while increasing slightly for Ginnie Mae. July-released factors indicated that prepayments decreased 6.69% for Fannie Mae and 12.59% for Freddie Mac, while increasing 3.72% for Ginnie Mae. Fannie ARM speeds decreased 1.8 CPR to 25.1, Freddie fell 3.4 CPR to 23.6, and Ginnie rose 1.1 CPR to 30.7.
Shorter-reset LIBOR-based Fannie 3/1s decreased 1.8 CPR to 24.4 and 5/1s decreased 2.2 CPR to 29.6. Longer-reset 7/1s decreased 1.5 CPR to 25.6 and 10/1s decreased .9 CPR to 16.7. In the Ginnie sector, Treasury-based 3/1s, 5/1s, and 7/1s paid 29.4 CPR (-7.55%), 31.5 CPR (+12.5%), and 28.7 CPR (+111.03%), respectively.
Last week, ARM activity was light and primarily focused on the following:
- New issue Ginnie 5/1 3.5s with approximately five years to reset traded at a moderate premium (< $103). With the bulk of the market still at a premium, prepayment risk is still a concern for many investors, and 5/1 borrower prepayment speeds tend to be more muted than 3/1s.
In new-issue space, 10/1 hybrids are attractively priced with spreads in the mid-80s (see Spread by Product chart above). 10/1 borrowers are paying ~25 bps higher in rate compared to a 7/1 borrower for the three extra years of fixed-rate period, and as a result these borrowers likely intend to be in their loans for longer than 5/1 or 7/1 borrowers. This was reflected in June 2019 prepayment speeds:
5/1 Hybrid ARM 29.6 CPR
7/1 Hybrid ARM 25.6 CPR
10/1 Hybrid ARM 16.7 CPR
As you can see, 10/1s have paid slower and they offer the widest spread with spreads in the mid-80s (~49 bps wider than a year ago).
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.
The following chart reflects the week-over-week change in Z-spreads for ARMs. Z-spreads were wider for GNMA, but tightened for FNMA and FHLMC products.
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP