May 6, 2019
Yield spreads between hybrid ARMs and Treasuries were unchanged last week, as the broader bond market moved down in price, sending yields slightly higher across the curve. ARMs lagged their fixed-rate MBS counterparts, with yield spreads tightening 3 bps on the 15-year fixed. We continue to see relative value in ARMs as they remain 10 to 24 bps wider compared to levels in early December.
April issuance remained strong and totaled $1.5bn, a level not reached since May 2018. Issuance by Fannie Mae and Freddie Mac was again almost entirely in LIBOR-based ARMs. Freddie Mac accounted for most of the monthly increase, issuing approximately $1bn for the month. In aggregate, 7/1s saw volumes totaling 694.4mm and they continue to make up the largest reset type, accounting for nearly 46% of total originations. 5/1s were the second largest reset type, accounting for approximately 38% of gross issuance.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- Fannie Mega 10/1s with ~ 3.7% coupons and ~ 9.5-year resets traded at a moderate premium ($102+).
- Seasoned 5/2/5 cap 7/1s with ~ 5-year resets traded.
In new issue space, 10/1 hybrids are attractively priced with spreads in the mid-50s. 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 March 2019 prepayment speeds:
5/1 Hybrid ARM 26.8 CPR
7/1 Hybrid ARM 20.1 CPR
10/1 Hybrid ARM 11.2 CPR
As you can see, 10/1s have paid slower and they offer the widest spread with spreads in the mid-50s (~24 bps wider than a year ago).
The desk continues to look to bid odd-lot positions 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 two weeks change in Z-spreads for ARMs. With a couple of exceptions, Z-spreads widened for GNMA, FNMA, and FHLMC products
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP