August 12, 2019
Mortgages were unable to keep pace with Treasury prices last week as yield spreads for current coupon MBS to Treasurys widened, with 30-year widening by 8 bps and 15-year widening by 2 bps. Surprisingly, higher coupons widened less than current production coupons. The overall cheapening trend can likely be attributed to seasonal supply and August prepayment factors.
August factors were released last week and prepayments were up across the board. Fannie Mae 30-year fixed rate mortgages surged 29%, while 15-year increased 15%. Borrowers originated in late 2018/early 2019 continue to be the fastest paying block due to their significant rate incentive. Next month should also see an increase in speeds as interest rates have continued to decline and the number of homeowners who can refinance has increased. The complete Vining Sparks Prepayment Commentary can be found here.
Activity increased significantly last week as investors took advantage of the bond market rally to sell odd-lots, underperforming positions, and seasoned TBA deliverable 10- and 15-year pools. A consistent trade has been to sell seasoned TBA deliverable FNMA/FHLMC 10- and 15-year into the TBA bid. The TBA bid for seasoned pools can result in a negative take-out yield (projected yield to the buyer) to the Treasury curve. The trade works best for coupons ranging from 2.50% to 4.00% with a current weighted-average maturity of 80 months or less. Reinvestment has generally been focused on specified pools (smaller loan balances) and/or higher duration product with locked-out cash flow.
Outright buying activity was focused on lower coupon 15- and 20-year pools and 30-year pools with relocation collateral or jumbo loans. The following is a list of actively traded sectors and coupons:
- 15-Year 2.0s to 4.0s – 2.0s remain the only coupon trading under par and offer relatively attractive spreads with rates unchanged or declining rate environments. The higher coupons tend to offer higher nominal spreads and superior OAS performance.
- 20-Year 2.5s & 3.0s – Newer production 20-year pools offer higher projected yields, and tend to perform relatively well in stable to rising interest rate scenarios.
- Off-The-Run-Collateral – Buyers seeking higher yields have focused on MBS pools collateralized by non-conforming jumbo loans and pools of relocation loans. Relocation loans are often considered a complement to traditional TBA pools. Expected prepayments tend to be more dependent on time rather than the relative level of market rates. This provides some level of resistance to refinance activity and limited extension risk.
- CMBS – The focus for CMBS (Fannie DUS & Freddie Ks) was on finals in the 7- to 12-year range. This has been a prevalent trade for investors seeking locked-out cash flow, positive convexity, and higher yields.
Mortgage Rates and Refinance Activity
Benchmark mortgage rates were mixed last week. 15-year mortgage rates declined 5 bps to 3.09%, while 30-year mortgage rates held firm at 3.83%.
Mortgage applications rose 5.3% from the previous week. The unadjusted purchase index fell 2% from a week ago but remained 7% higher than the same week a year ago. The seasonally adjusted purchase index fell 2% from the week before.
The refinance index moved forward 12% from last week and was 116% higher than the same time period in 2018. Lower rates have pushed up the refinance index to a reading of just over 2,000, its highest level since November 2016. The refinance share of mortgage activity increased to 53.9% from last week’s 50.5%.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP