April 1, 2019
Yield spreads on current production MBS to Treasuries were mixed last week, with 15-year tightening 2 bps to 43 bps, while 30-year widened 5 bps to 70 bps. Since year-end, yield spreads have tightened incrementally by 7 to 10 bps, which is relatively modest given the moves experienced in other fixed income sectors.
The change in pricing has spurred solid two-way flow across the MBS desk, with investors selling lower-performing securities and adding new positions. Investors have been drawn to both floating-rate product and duration within the sector.
The bond market rally and significant reduction in rates has sent the mortgage refinance index higher in recent weeks after drifting lower for most of 2018. For the week ending 3/22, the refinance index climbed to 1,290, which is up 559 points from year-end. This trend has impacted investor demand to a degree, as we’ve seen MBS investors seemingly more focused of late on lower premiums and less prepayment risk.
The following represents an overview of the activity last week:
- Investors focused on seasoned 15-year 2.0’s and 2.5’s trading at a discount. These seasoned pools tend to have less negative convexity and exhibit better projected performance in a declining rate environment versus higher coupons.
- We’ve seen buying in seasoned and new production pools. Seasoned 2.5’s and 3.0’s at a discount have attracted investors seeking potential appreciation with declining rates.
- Activity has picked up within this space over the past several months as depositories have focused on adding duration. Tax reform and basis tightening in Municipals has also led some investors to consider longer term MBS. A recent Strategic Insight on this topic can be found here.
- An active trade for investors seeking potentially higher yields and relatively low price volatility has been in current production GN II 5.0’s, trading near $105. Although this is new production 30-year paper, the projected price volatility is relatively low (ranging from -12.0% to -13.0% with rates up 300 bps), primarily because of the higher coupons and prepayment patterns typically associated with FHA/VA borrowers.
- Other trades included several custom GNMA pools designed to help depositories meet their Community Reinvestment Act (CRA) goals for 2019.
- Most of the demand has been for floating rate structures (Freddie K’s and FN ACES in which the fixed-rate cash flow has been swapped out for floating-rate cash flow). A prevalent trade has been a newer issue FN ACE 11-year final trading at a discount, offering a yield near 3.00%.
Mortgage Rates and Refinance Activity
Benchmark mortgage rates continued to decline last week. 15-year mortgage rates decreased 5 bps to 3.42%, while 30-year mortgage rates declined 9 bps to 4.08%, marking the lowest level in over a year. The 30-year mortgage rate has declined 74 bps from its high in early November 2018.
Mortgage Applications Improve as Rates Continue Recent Decline: Mortgage applications rose 8.6% last week, the third strongest weekly gain of the year and the fourth biggest week since the middle of 2016. Lower rates are expected to aid stabilization in the housing sector but most series have yet to reflect a discernible positive effect. However, the general trend for mortgage applications has improved in recent weeks as the MBA’s mortgage rate estimates have declined.
Pending Home Sales Pulled Back Following Impressive January Jump: Pending home sales slipped more than expected in February after surging in January by the most in more than eight years . Pending sales, counted when contracts are signed and a leading indicator of existing sales in the months ahead, fell 1.0% last month. January’s impressive jump was revised slightly lower from 4.6% to 4.3%. Averaging through the monthly volatility, pending sales are up 3.2% from December but down 5.0% from a year ago. Regionally, the results were mixed as an unusually weak month for activity in the Midwest offset smaller gains in the South and West. Contract signings tumbled 7.2% in the Midwest, the largest drop (by 2.9%-points) since June 2010, while signings rose 1.7% in the South and 0.5% in the West. Recent housing data have been mixed, but purchase applications appear to have perked up recently, potentially the positive effects of lower mortgage rates. Despite an impressive 11.8% spike in February’s existing sales report last week, the second largest on record, the negative month for pending sales portends a more consistent recovery in home sales may still be some months off.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP