August 17, 2020
The Fed’s aggregate mortgage buying was $22.0bn last week. The most concentrated purchases were in production coupons of UMBS 30-year 2.0s and 2.5s, with volumes of $7.9bn and $5.2bn, respectively. The Fed has purchased over $900bn of agency MBS since resuming QE in mid-March. Some analysts project the Fed is currently buying 50-60% of new production generic TBA collateral. The impact to the sector has been significant in terms of reduced volatility and much higher prices.
Current Yield Spreads
MBS gave up some ground to Treasurys last week with spreads widening after two consecutive weeks of outperformance. Nominal spreads on 15-year MBS to Treasurys widened 4 bps to 49 bps and 30-year MBS widened 5 bps to 76 bps.
Prepayment concerns and lack of supply are the challenging factors for MBS investors. With approximately 80% of the mortgage market being in the money to refinance, buyers have focused on lower coupons and pools with characteristics that make prepayments less likely (low loan balances, 100% NY, low FICOs, investor loans).
The summary below reflects the most active trades from last week.
- UMBS 15-year 1.5s to 2.5s
- UMBS 20-year 1.5s to 3.0s (2.0s the most traded)
- UMBS 30-year 1.5s to 3.5s (2.5s the most traded)
- FNMA Jumbos (FNCK 2.0s to 3.0s)
- GNMA Jumbos (MJM 2.0s to 3.0s)
- 15- and 30-Year 2.0s to 3.0s LLB Pools ($85k -$200k max loan size)
- Custom CRA Pools
Given the robust refinance activity, portfolio managers continue to seek prepay protection to avoid potentially low or negative yields. Many investors have turned to specified pools (lower loan balances, NY collateral, investor loans) to help partially mitigate faster prepay speeds. The graph below highlights monthly prepayment speeds on different collateral types.
Mortgage Rates and Refinance Activity
Mortgage rates increased slightly last week but remain near historic lows. Freddie Mac reported that the 30-year fixed-rate mortgage in its survey increased 8 bps to 2.96%. The rate was 2.88% one week ago and 3.60% one year ago. The 15-year mortgage rate increased 2 bps to 2.46%.
Mortgage applications for the week ending August 7 rose 7% compared to the previous week. Mortgage applications to purchase a home were up 2% from last week and were 22% higher than the same week one year ago. Mortgage applications to refinance a home were up 9% over the previous week. The refinance index is at 4,025, which is the highest level since April 17.
Last week loan originators tightened the primary/secondary spread following a period of widening over several weeks. The spread decreased 5 bps to 1.80% but remains well over the trailing one-year average of 1.44%. The trailing five-year average is 1.18%, therefore, mortgage rates have plenty of room to decline further if we see a reversion in the primary/secondary spread.
On August 12th, both Fannie Mae and Freddie Mac announced a new 50bps “adverse market fee” that will apply to substantially all refinancing transactions. The 50bps fee will be implemented, according to the Enterprises, due to increased risk and anticipated higher costs related to COVID-19 and will be effective on September 1st, 2020. For the average mortgage backed by Fannie Mae and Freddie Mac, it will equate to an additional $1,400 in expense to refinance a mortgage. The fee can be paid upfront or spread evenly over the life of the mortgage in the form of a higher rate. Most expect the fee to add 10-12 bps to the current mortgage rate. The extra fee provides some prepayment friction but is unlikely to slow refinance activity significantly.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP