March 5, 2018
Yield spreads between new-issue hybrid ARMs and Treasuries widened 1 to 2 basis points last week. Spreads have been relatively stable partially because of the lack of supply in the market. Preliminary estimates for February indicate originations totaled $1.26 billion, a decline of 16.4% from the previous month.
As depicted on the graph below, there has been some narrowing between interest rates on 3/1s and traditional 30-year fixed mortgages, which could lead to higher origination activity.
Last week, activity was primarily focused on the following:
- New Issue Conventional 7/1s – These structures continue to compare well to 10- to 15-year MBS in terms of yield, price volatility, OAS, and total return.
- GN 5/1 2.5s – Trading at a discount, which has eliminated the sensitivity to faster prepayments.
- 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 bond resets. Using a vector to model this behavior shows that seasoned short resets can compare favorably to other adjustable-rate alternatives.
Metrics for some commonly traded structures are below:
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG