September 9, 2019
Last week, demand for new-issue hybrid ARMs improved, which resulted in yield spreads to Treasurys tightening 2 to 3 basis points. Spread tightening found in the hybrid ARM sector was mirrored in the fixed-rate MBS sector as 15-year and 30-year fixed-rates tightened 2 and 6 bps, respectively. On the contrary, the broader bond market moved down in price, sending yields higher across the curve. Last week’s data should have little implication for this month’s US Federal Reserve meeting, as policymaker commentary over the summer suggests an additional rate cut is likely, not least given ongoing trade-related uncertainty. We continue to see relative value in longer-reset 7/1s and 10/1s as they remain approximately 47 and 45 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 were mixed for GNMA, FNMA and FHLMC products.
New issuance for August totaled 507.6mm versus a higher level of 748mm in July. Supply was split amongst Fannie Mae (175mm), Freddie Mac (264.6mm), and Ginnie Mae (68mm). Supply was focused in 7/1s (223.7mm) with 5/1s and 10/1s issued in similar amounts of 137.2mm and 140mm, respectively. ARM gross issuance remains at multi-year lows as it came under 1 billion for the fourth consecutive month.
Hybrid ARM issuance remains quite low. As of August, hybrid ARM issuance represented ~ 0.65% of overall MBS issuance. The ARM sector continues to be plagued with low supply and minimal new issuance.
Prepayments changed trend as August prepayments for hybrid ARMs were mixed. September-released factors indicated that August ARM prepayments decreased 1.25% to 2.46% for Ginnie Mae and Fannie Mae, respectively, and increased 0.37% for Freddie Mac. In aggregate, Fannie ARM speeds decreased 0.7 CPR to 27.8, Freddie rose 0.1 CPR to 27.2, and Ginnie decreased 0.4 CPR to 31.6.
Shorter-reset LIBOR-based Fannie 3/1s increased 4.8 CPR to 29.1 and 5/1s decreased 2.2 CPR to 30.5. Longer-reset 7/1s slightly decreased 0.7 CPR to 28.8 and 10/1s increased 1.2 CPR to 22.3. In the Ginnie sector, Treasury-based 3/1s, 5/1s, and 7/1s paid 31.4 CPR (no change), 31.6 CPR (-2.47%), and 41.4 CPR (+7.6%), respectively.
Last week, ARM activity was spread across a variety of lists and primarily focused on the following:
- Moderately-seasoned Fannie 7/1s with higher coupons (2.65%+) and ~ 5-year resets traded at a moderate premium ($101+).
- Seasoned Fannie Mega 7/1s with coupons in excess of 2.2% and 12 months to reset traded near the 101.75 handle. 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