June 10, 2019
For the fifth consecutive week, demand for new-issue hybrid ARMs slowed, which resulted in yield spreads to Treasurys widening 1 to 2 bps. With weak labor data and the lack of tariff solutions, the broader bond market moved up in price, sending yields lower across the curve. ARMs lagged their fixed-rate MBS counterparts, with yield spreads tightening 2 bps on the 15-year fixed and 5 bps on the 30-year fixed. We continue to see relative value in ARMs as they remain 13 to 34 bps wider compared to levels in early December.
The ARM origination cycle continued last week, with 138.3mm in new issue ARM selling split amongst Fannie Mae (81.4mm), Freddie Mac (29.2mm), and Ginnie Mae (27.7mm). Supply was focused in Fannie Mae 7/1s (31.8mm) and Fannie Mae 5/1s (28.6mm). Ginnie Mae also contributed to gross issuance with 26mm in 5/1s. Most of Freddie Mac’s new issues were concentrated in longer-reset 10/1s (19.7mm). After strong issuance last month, ARM issuance levels were light last month totaling 631mm.
For the fourth consecutive month, prepayments increased 8.82% to 17.39% for all three agencies. In aggregate, Fannie ARM speeds increased 3.3 CPR to 27.4, Freddie rose 4 CPR to 27.0, and Ginnie increased 2.4 CPR to 29.6.
Shorter-reset LIBOR-based Fannie 3/1s increased 3.8 CPR to 28.4 and 5/1s increased 3.6 CPR to 32.6. Longer-reset 7/1s increased 3.9 CPR to 27.4 and 10/1s increased 2.1 CPR to 17.9. In the Ginnie sector, Treasury-based 3/1s, 5/1s, and 7/1s paid 31.8 CPR (+6%), 28 CPR (+11.55%), and 13.6 CPR (-39.56%), respectively.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- Seasoned Ginnie 3/1 2s and 3s with less than 20 months to reset traded at a slight premium.
- New-issue Ginnie 5/1 3.5s with approximately 5 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.
- Seasoned Fannie Mega 7/1s with coupons around 2.7% and ~ 2.5-year resets traded at a slight premium. This conventional ARM has a generous cap structures relative to GNMAs at 5/2/5. This lends to lower price impacts from rising rates.
In new issue space, 10/1 hybrids are attractively priced with spreads in the low-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 3 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 May 2019 prepayment speeds:
5/1 Hybrid ARM 32.6 CPR
7/1 Hybrid ARM 27.4 CPR
10/1 Hybrid ARM 17.9 CPR
As you can see, 10/1s have paid slower and they offer the widest spread with spreads in the low-80s (~46 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 tightened for GNMA, FNMA, and FHLMC products.
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP