October 1, 2018
It was a relatively quiet end to the quarter in ARMs. Last week, we saw more Ginnie Mae II ARM origination, focused in 5/1 hybrids. Gross issuance of adjustable MBS for the month came in at 1 billion, which was an approximate 300 million decline month over month. Most of the decline occurred as a result of reduced Ginnie Mae II ARM issuance, which was elevated in August. Overall, ARMs had a lackluster third quarter. Despite rates selling off and fixed rate MBS trading well, 7/1 hybrid ARM spreads are roughly unchanged versus the beginning of the quarter. As a result, ARMs look attractively priced heading into the fourth quarter.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- 5/2/5 cap structure Fannie Mega 5/1s with reset dates inside of 12 months and gross weighted average coupons near 3.25% traded at a moderate premium
- Fannie Mega 7/1s with reset dates in mid-2020 and an initial fixed rate of 2.10%+ traded just above par
- Seasoned Ginnie Mae II 5/1s with coupons around 3% and reset dates inside of 24 months traded at a moderate premium
Also, seasoned Fannie Mae 10/1s with a 5/2/5 cap structure and slightly less than 60 months-to-reset (MTR) at a moderate discount proved popular. Dollar prices for conventional hybrid ARMs have been low for an extended period and generally, they have a higher minimum speed threshold, which translates into solid cashflows for the investor. In some cases, hybrid ARMs have higher option-adjusted spread (OAS) versus their fixed-rate counterparts and an appealing yield given their lower price volatility. Because hybrid ARMs reset off LIBOR plus a margin during the floating rate period, the investor is compensated with a higher coupon, which serves to mitigate extension risk. Since the bonds will reset higher, the price of the bond at reset is historically in excess of par (~ $101 – $103.5).
The following chart reflects the week over week change in LIBOR option-adjusted spreads for ARMs. GNMA and FNMA/FHLMC with 32+ months-to-reset (MTR) tightened reflecting higher prices and outperformance.
Ricky Brillard, CPA
Vining Sparks, IBG