March 12, 2018
Yield spreads between new-issue hybrid ARMs and Treasuries were stable last week. As depicted on the graph below, final issuance for February totaled $1.26bn, a decline of $249mm from the previous month. 7/1s outpaced all other reset types with $461mm in issuance, accounting for 36% of total originations in the sector. Based on current activity, issuance could likely bottom in March and potentially pickup in April due to seasonality. Although the flattening yield curve has reduced the incentive for borrowers to select an ARM over a traditional fixed-rate mortgage, ARMs should nevertheless appeal to some borrowers looking for any reduction in payment amid the overall increase in mortgage rates this year. This year, according to Bankrate.com, thirty-year fixed-rate conventional mortgage quotes have increased over 40 bps, while fifteen-year fixed-rate quotes have risen nearly 50 bps.
For the fourth month in a row, prepayments for conventional hybrid ARMs declined. In aggregate, Fannie ARM speeds went down 1.3CPR to 17.5CPR. Libor-based Fannie 5/1s slowed 1.0CPR to 22.1CPR, 7/1s decreased 1.9CPR to 14.3CPR, and 10/1s declined 1.2CPR to 11.9CPR. In the Freddie sector, 5/1s, 7/1s, and 10/1s paid 22.6CPR (-0.8CPR), 13.6CPR (-1.0CPR), and 11.3CPR (+0.7CPR), respectively.
In aggregate, Ginnie ARM speeds were relatively stable, increasing 1.55% or 0.3CPR, to 19.7CPR. The modest increase was driven largely by an increase in 3/1s, which paid at 19.9CPR in February compared to 19.2CPR in the previous month. This is still off nearly 12% from the average pace of 22.6CPR over the last twelve-months.
The overall theme in the ARM sector is the emergence of lower prices resulting from the latest bond market sell-off. For example, measuring prices at origination, 5/1s have declined from a recent trading level of roughly $102.5-$103.0 (November 2017) to near $101.0. In addition, new issue 3/1 2.5’s are now trading just above par, which partially mitigates the premium exposure related to higher prepayment speeds.
Last week, activity was primarily focused on the following:
- New Issue Conventional 7/1s – These structures continue to compare favorably to 10- to 15-year MBS in terms of yield, price volatility, OAS, and total return.
- Short Resets – Investors are also targeting conventional short resets (3- to 6-months to the reset date) to hedge against further increases in market rates. Current prepayment activity is elevated since most of these bonds are nearing their initial reset dates. However, based on historical patterns, prepayment activity generally declines after the bonds reset. Using a vector to model this behavior shows that seasoned short resets can compare favorably to other adjustable-rate alternatives.
- GN 3/1 2.0’s and 2.5s – 3/1 buyers are adding 2.0s at a discount and benefiting from the aforementioned improvement in pricing for higher coupon 2.5s.
Metrics for some commonly traded structures are below:
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG