September 30, 2019
Last week, yield spreads between hybrid ARMs and Treasurys were mixed with Ginnie 2s widening approximately 2 to 3 basis points and conventionals tightening approximately 1 or 2 basis points. Mortgage-related sectors were also mixed with 15-year fixed-rate mortgages tightening 1 basis point and 30-year fixed-rate mortgages widening 2 basis points. The broader bond market moved up in price, sending yields lower across the curve as weak data and political uncertainty offset positive trade developments. We continue to see relative value in longer-reset 7/1s and 10/1s as they remain approximately 34 bps wider compared to levels in early March.
The following chart reflects the week over week change in Z-spreads for ARMs. Z-spreads were mixed for GNMA, FNMA and FHLMC products.
The ARM origination cycle continued last week, with 160.9mm in new issue ARM selling split amongst Fannie Mae (8.9mm) and Freddie Mac (152mm). Supply was focused in 7/1s with Freddie Mac issuing 73.7mm and Fannie Mae issuing 6.8mm. Freddie Mac also contributed to longer-reset 10/1 issuance with 60.2mm. With 617mm originated month-to-date, September’s ARM issuance levels have exceeded August’s levels with 1 business day remaining in the month. ARM gross issuance remains at multi-year lows as it will likely come under 1 billion for the fifth consecutive month in September.
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 September, hybrid ARM issuance represents ~ 0.75% of overall MBS issuance. Nevertheless, issuance volumes have been at their highest levels in Ginnie Maes, followed by Freddie Mac and despite the meager volumes, September hybrid ARM issuance as a percentage of overall MBS issuance trended slightly higher versus August.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- New issue Fannie Mega 7/1s with coupons ~ 3.3% and ~ 5-year resets traded at a moderate premium ($103). This conventional ARM has a generous cap structures relative to GNMAs at 5/2/5. This lends to lower price impacts from rising rates.
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