June 24, 2019
For the seventh consecutive week, demand for new-issue hybrid ARMs slowed, which resulted in yield spreads to Treasurys widening 1 to 2 bps. With central bankers in Europe and the US signaling a willingness to ease policy in response to growing risks to the global economy, the broader bond market moved up in price, sending yields slightly lower across the curve. ARMs lagged their fixed-rate MBS counterparts, with yield spreads tightening 7 bps on the 15-year fixed and 12 bps on the 30-year fixed. We continue to see relative value in ARMs as they remain 27 to 43 bps wider compared to levels in early December.
The ARM origination cycle continued last week, with 265.3mm in new issue ARM selling split amongst Fannie Mae (75.8mm), Freddie Mac (172.8mm), and Ginnie Mae (16.7mm). Supply was focused in Freddie Mac 10/1s (83.1mm), Freddie Mac 7/1s (64.2mm), and Fannie Mae 7/1s (66.8mm). Freddie Mac also contributed to gross issuance with 25.5mm in 5/1s. With 499.6mm originated month-to-date, June’s ARM issuance levels are on pace to be light again with 5 business days remaining in the month.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- 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.
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 three 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, FNMA and FHLMC products.
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP