November 13, 2018
We’ve seen a recovery in ARM demand in November after the sector widened out alongside all spread assets in October. The low dollar prices on newly originated ARMs has reduced the impact of increased rate volatility and the need for convexity hedging, a positive for the sector. Currently, ARM spreads remain near the wides of the year.
Last week, ARM activity was spread across a variety of lists. Fannie Mega 7/1s with a fixed-rate period greater than 80 months and a fully-indexed rate in excess of 4.7% traded near par. This product is an alternative for portfolio managers who may wish to consider diversification into a different collateral type. It offers similarities to fixed-rate MBS with the longer fixed-rate period followed by a 5% initial reset, which decreases the price volatility. These pools have a low dollar price, strong cash flow, attractive yield, and relatively low price volatility with potential price upside as these pools near reset.
Also, new seasoned Fannie Mega 5/1s with reset dates inside of 12 months and gross weighted average coupons just above 3% traded at a moderate premium. These pools are a mixture of very short-reset bonds and longer-reset collateral. The short-reset bonds trade at higher dollar prices, their coupons reset soon, and short-term speed is expected. The longer-reset collateral brings dollar prices down and should serve to mitigate prepayment spikes as the short-reset pools go higher in coupon. These pools provide exceptional value especially when used as the short-end of a barbell strategy.
The following chart reflects the week over week change in LIBOR option-adjusted spreads for ARMs. With the exception of shorter-reset agencies, GNMA, FNMA, and FHLMC ARM OAS’s tightened.
The bulk of November ARM origination is set to take place this week, leading up to Class D settlement next Tuesday. Last month, issuance decreased very slightly for Freddie Mac, down $0.08B to $0.23B, decreased $0.19B to $0.45B for Fannie Mae, and increased by $0.09B to $0.2B for Ginnie Mae.
ARM prepayments increased for all 3 agencies, but the increases were only 20% or so of the decreases seen in September. Expect at-reset and post-reset speeds to marginally accelerate this month as a result of the increased day count. Any signs of further slowdown or burnout would be a positive for the sector and tail values in general.
Ricky Brillard, CPA
Vining Sparks, IBG