September 17, 2018
We saw new issue ARM origination last week, focused in 7/1s and 10/1s. Current coupon spreads have widened over the past month and over the course of the summer. New issue pool sizes have decreased recently because of reduced ARM issuance. However, larger pools remain available in slightly seasoned space, where spreads have also widened in sympathy with new issue.
Last week, ARM activity was primarily focused on the following:
- 5/2/5 cap structure Fannie Mega 5/1s with 8 months-to-reset (MTR) and WACs near 3.25% traded at a moderate premium – 5/1s in general look on the tighter side, as spreads are only slightly wider versus the beginning of the year (adjusting for dollar price)
- In seasoned space, 23 months-to-reset (MTR) 5/1s with coupons near 2.25% traded near par
- Seasoned Fannie 10/1 hybrids with a 5/2/5 cap structure and WACs in excess of 4% traded at a moderate premium
Also, we saw 5/2/5 cap structure Fannie 7/1s maturing in 30-years with 78 months-to-reset (MTR) trade near par. Dollar prices for conventional hybrid ARMs have been low for an extended period and generally speaking, 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, FNMA, and FHLMC ARM OAS’s tightened.
Ricky Brillard, CPA
Vining Sparks, IBG