ARM Update

June 1, 2020

Strong monetary and fiscal support, optimism around vaccine progress, and the easing of lockdown restrictions have been positives for risk assets recently.  However, risk-on moves continue to be interrupted by hostile U.S. – China relations.  A moderation in weekly jobless claims has been encouraging, however it will take time for the labor market to return to its pre-virus state.  On the week, yield spreads on Ginnie 3/1 ARMs tightened 10 bps while conventional ARMs tightened 12-20 bps.  Contrary to their adjustable-rate counterparts, 15- and 30-year fixed rate mortgages widened 5 and 7 bps, respectively, on the week.

Since the market dislocation in mid-March, ARM pricing spreads have tightened, but remain at attractive levels.  For example, 5/1 conventional ARMs have a 55 bp spread, almost 25 bps wider than they were in March 2019.  Longer-reset 7/1 and 10/1 conventionals have a 70 and 90 bp spread, respectively, approximately 30 and 43 bps wider.  Relative value players may find Ginnie 5/1s to be attractive with their 130 bp spread, approximately 93 bps wider than early 2019 levels.

Last month, ARM issuance increased to 1.82 billion, the strongest level since October 2017.  Supply was split amongst Fannie Mae (838.5mm), Freddie Mac (963.3mm), and Ginnie Mae (22.8mm).  Supply was focused in longer-reset 7/1s (781.3mm) and 10/1s (795.4mm) while 5/1s were issued in an amount of 246.6mm.  Minimal (1.3mm) 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, but finally broke the 1-year run of monthly issuance under $1 billion, and increased supply to levels not seen in over two and a half years.  Last year, 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 June, hybrid ARM issuance represented ~ 1.01% of overall MBS issuance.

On November 15, 2019, the Alternative Reference Rates Committee (ARRC) released recommendations on contract fallback language to be used for new closed-end residential adjustable-rate mortgages (ARMs).  The recommended fallback language for each of these products is based on the following framework:

A recent Vining Sparks’s publication provides the latest developments and planning steps for the transition from LIBOR.

On July 11, 2019, 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 ARRC’s 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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