ARM Update

June 22, 2020

After risk-off investor sentiment resurfaced last week on fear of a second wave of coronavirus, risk appetite returned after the Fed released an update to the Secondary Market Corporate Credit Facility (SMCCF) announcing it will begin purchasing individual corporate bonds in the secondary market.  On the data front, U.S. retail sales surged by 17.7% in May, the greatest monthly increase on record dating back to 1992.  On the week, yield spreads on Ginnie and conventional ARMs were unchanged while fixed-rate mortgages widened 9 to 11 basis points.  Mortgages have struggled to keep up with other risk assets recently due to heavy TBA mortgage supply during the peak summer home buying season.

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 52 bp spread, almost 22 bps wider than they were in March 2019.  Longer-reset 7/1 and 10/1 conventionals have a 65 and 80 bp spread, respectively, approximately 25 and 33 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.

The ARM origination cycle was light last week, with 371.2mm in new-issue ARM selling split amongst Fannie Mae (94.6mm), Freddie Mac (273.3mm), and Ginnie Mae (3.3mm).  Supply was focused in longer-reset 7/1s and 10/1s with Freddie Mac issuing 112.1mm and 96.8mm, respectively.  No 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.  The decline closely tracks 5/1 hybrid ARM rate spread to the 30-year fixed mortgage rate, which has dropped to approximately 10 basis points.  As of June, hybrid ARM issuance represented ~ 0.61% 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

The information included herein has been obtained from sources deemed reliable, but it is not in any way guaranteed, and it, together with any opinions expressed, is subject to change at any time. Any and all details offered in this publication are preliminary and are therefore subject to change at any time. This has been prepared for general information purposes only and does not consider the specific investment objectives, financial situation and particular needs of any individual or institution. This information is, by its very nature, incomplete and specifically lacks information critical to making final investment decisions. Investors should seek financial advice as to the appropriateness of investing in any securities or investment strategies mentioned or recommended. The accuracy of the financial projections is dependent on the occurrence of future events which cannot be assured; therefore, the actual results achieved during the projection period may vary from the projections. The firm may have positions, long or short, in any or all securities mentioned. Member FINRA/SIPC.
Copyright © 2021
This is a publication of Vining-Sparks IBG, L.P.
775 Ridge Lake Blvd., Memphis, TN 38120