June 17, 2019
For the sixth consecutive week, demand for new-issue hybrid ARMs slowed, which resulted in yield spreads to Treasurys widening 1 to 2 bps. Against the backdrop of trade uncertainty and rising expectations for easier central bank policy, the broader bond market moved up in price, sending yields slightly lower across the short-end of the curve. ARMs outperformed their fixed-rate MBS counterparts, with yield spreads widening 4 bps on the 15-year fixed and 11 bps on the 30-year fixed. We continue to see relative value in ARMs as they remain 13 to 35 bps wider compared to levels in early December.
New issue ARM flows were light last week, with 96mm in new issue ARM selling split amongst Fannie Mae (69.3mm), Freddie Mac (20.9mm), and Ginnie Mae (5.8mm). Supply was focused on Fannie Mae 10/1s (40.6mm) and Fannie Mae 7/1s (24.6mm). Freddie Mac also contributed to gross issuance with 14.6mm in 7/1s. After strong issuance in April, ARM issuance levels were light last month totaling 631mm.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- Seasoned Freddie Mac 10/1s with ~ 75 months-to-rest traded at a slight premium. With the bulk of the market still at a premium, prepayment risk is still a concern for many investors, and 10/1 borrower prepayment speeds tend to be more muted than 3/1s, 5/1s, and 7/1s.
- 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 (~48 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 products and tighter for FNMA and FHLMC products.
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP