November 4, 2019
Yield spreads on hybrid ARMs to Treasurys widened a basis point or two last week, while mortgage-related sectors experienced spread tightening. The 15-year fixed-rate mortgage saw spreads tighten 3 basis points and the 30-year fixed-rate mortgage experienced spread tightening of 7 basis points. The broader bond market moved up in price, sending domestic yields lower across the curve. Last week, the Fed lowered its policy rate for the third time this year and the ECB resumed asset purchases. More broadly, monetary easing is currently underway in economies that represent around 70% of global GDP. Coordinated easing is due to central banks contending with an unusual environment, with policy responding to a trade shock as well as continued low inflation and tight labor markets. We continue to see relative value in longer-reset 7/1s and 10/1s as they remain approximately 39 and 41 bps wider, respectively, compared to levels in early March.
The following chart reflects the week over week change in Z-spreads for ARMs. Z-spreads tightened for shorter-reset Ginnies, widened for longer-reset products, and remained stable for conventionals.
New ARM issuance for October totaled 807.5mm, the highest level since April 2019. Supply was split amongst Fannie Mae (455.1mm), Freddie Mac (286mm), and Ginnie Mae (66.4mm). Supply continues to be focuses focused in 7/1s (373.9mm) with 5/1s and 10/1s issued in amounts of 195.7mm and 236.9mm, respectively. 3/1 ARM products continue to be largely abandoned by lenders and the GSEs. ARM gross issuance remains at multi-year lows as it came under 1 billion for the sixth-consecutive month.
Hybrid ARM issuance remains quite low. The monthly net supply of ARMs continues to run at a negative $2-3 billion pace, while fixed rates are expected to grow at $20-30 billion each month for the rest of the year. As of October, hybrid ARM issuance represents ~ 0.85% of overall MBS issuance. Nevertheless, issuance volumes have been at their highest levels in Ginnie Maes, followed by Fannie Mae and despite the meager volumes, October hybrid ARM issuance as a percentage of overall MBS issuance has trended slightly higher versus August and September.
On July 11th, the Alternative Reference Rates Committee (ARRC) released a white paper detailing how an average of the Secured Overnight Financing Rate (SOFR) can be used in newly-issued ARMs in a structure that is comparable to today’s existing ARM loans. The white paper shows how SOFR can be used to develop products that are built on a robust reference rate that is grounded in market transaction. Here’s an overview of the ARRC’s proposed models of SOFR ARMs:
- Most aspects of a SOFR-based ARM would use the same conventions that currently exist in US Dollar LIBOR-based ARMs, including the range of fixed-rate periods available, the timing of payment determinations, and the structure of caps on the amount that mortgage payments can rise at the end of the fixed-rate period and over the life of the mortgage.
- However, a few key components would differ:
- These ARMs would be based on a 30- or 90-day average of SOFR, rather than 1-year LIBOR. Because SOFR tends to be lower than 1-year LIBOR, the margin for newly originated SOFR-indexed ARMs would likely be adjusted upward so borrowers’ overall floating-rate payments are comparable to existing LIBOR-based ARMs.
- In order to ensure that these SOFR-indexed ARMs can be offered at rates consistent with other competitive rates in the market, under the proposed models SOFR-indexed ARM, the borrower’s monthly floating-rate payment would adjust following the fixed-rate period once every six months rather than once every year, as is currently the market standard for LIBOR-based ARMs in the United States.
- To safeguard against unexpected payment increases to the borrower, the proposed models would cut the periodic adjustment cap to 1%. As a result, the borrower’s payment, even in a period of rapidly rising interest rates, would not change by more than 2% over a 12-month period, in accord with the current market convention for LIBOR-based ARMs.
The desk continues to look to bid odd-lot positions for both conventionals and Ginnies 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.
Ricky Brillard, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP