November 26, 2018
Flows in ARMs were quiet last week. The ARM origination cycle continued with new issue selling of 15.3M in Fannie Mae 7/1s and 10.1M in Ginnie Mae 5/1s. ARM gross issuance remains at multi-year lows and supply is tracking close to last month (see below), when we saw just under 1 billion in total gross issuance.
Despite the lack of supply, the recent mortgage underperformance has caused spreads on ARMs to widen out. Year-to-date wides in spreads coupled with near lows in dollar prices have drawn investor interest. Demand has been focused in new issue 7/1s and 10/1s, which is where we have seen the most widening. The risk-on tone in the broader market this morning should be positive for spreads to start the week.
Demand in seasoned pools has been absent recently. Fears of fast speeds on lower coupons at their first reset has depressed tail values. However, faster speeds on ARM collateral could become a positive as more of the sector trades at a discount. See the average hybrid ARM CPR by agency below.
Last week, in addition to clean-up trades, we saw new seasoned Fannie Mega 5/1s with reset dates inside of 12 months and gross WACs just above 3% trade 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 (less than 30 months-to-reset) 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.
Ricky Brillard, CPA
Vining Sparks, IBG