June 11, 2018
Spreads were unchanged in ARMs last week despite the widening in their fixed-rate counterparts. Over the past several months, ARM spreads have moved wider as a result of higher WACs on new origination, which have higher option cost. Lower dollar price ARMs continue to have value, as future originations should continue to have higher WACs and increased prepayment risk.
Recently, the VA published a policy guidance update outlining the new immediate implementation of Fee Recoupment and Net Tangible Benefit tests for VA loans. The net tangible benefit test should reduce G2 ARM supply as borrowers need 2% rate savings to streamline refinance from a fixed-rate mortgage to an ARM. However, the net tangible benefit test should have less of an effect on G2 ARM speeds, as it focuses on refinancing from fixed rates. On the other hand, the fee recoupment should limit refinancing for borrowers without rate incentive. Expectations are the 40 CPR prints on discount 3/1s will not be sustainable with the new policy, and spreads should widen as durations extend.
Right now, new and moderately seasoned hybrid ARMs (i.e. 7/1s and 10/1s with 48-84 months to roll with 5/2/5 caps) have value for the following reasons:
- Dollar prices for conventional hybrid ARMs have not been this low in a long time.
- Hybrid ARMs generally have a higher minimum speed threshold, which means solid cashflow for the investor.
- Hybrid ARMs have an appealing OAS versus their fixed rate counterpart.
- Hybrid ARMs have an appealing yield given their lower price volatility.
- Because hybrid ARMs reset off of Libor + a margin during the floating period, the investor is compensated with a higher coupon, which serves to mitigate extension risk. Because these bonds will reset higher, the “tail value” (approximate price of the bond at the reset) is well north of par.
Last week, activity largely consisted of the following:
- Higher yields encouraged stronger demand in secondary space
- 50M of a 10/1 Fannie Mae for June settle with a 2.91% WAC
- 44.9M of a 7/1 Fannie Mae for June settle with a 3.624% WAC
- 41.2M of a 7/1 Freddie Mac for June settle with a 2.959% WAC
- 7.7M of 3/1 and 5/1 Ginnie Mae II Pools for June settle with WAC’s ranging from 2.577% to 3.822%
May factors were reported last week and prepayments were pretty neutral for ARMs. FNMA ARMs increased 7% overall, compared to a 9% increase in 30 years fixed-rate MBS. The increase was spread evenly across reset buckets and was expected due to higher day count and faster seasonals.
Ricky Brillard, CPA
Vining Sparks, IBG