August 20, 2018
Yield spreads on current production MBS underperformed Treasuries and widened slightly over the past week on a risk-off sentiment driven by geopolitical concerns. Both 15- and 30-year MBS yield spreads to Treasuries were wider by 1 to 2 bps.
Although mortgage rates have been fairly steady in recent weeks, mortgage applications have continued to trend lower. Mortgage application volume fell 2.0% for the week, with volume declining 19.0% from the same week one year ago. This marks the fifth weekly decline in purchase apps, matching the longest run since 2009. Weakening home affordability and a supply-demand imbalance continues to weigh on activity.
The soft patch in housing continued last week with construction on new houses increasing by less than 1.0% in July. Housing starts grew to an annual rate of 1.17 million during July, while most economists had expected starts to total 1.27 million. Meanwhile, rising construction costs and skilled labor shortages sent homebuilder confidence levels down marginally. The headline index moved down to 67 which marked its sixth monthly decline in 2018 and its lowest level in 11 months (64 in September 2017).
Most of the MBS trading activity last week continued to be concentrated on seasoned 15-year 2.5s and 3.0s, as investors sought after discounted paper with high scheduled cash flow. 15-year 2.5s have cheapened up 2 to 3 ticks during the last month. The following represents a summary of the activity we observed last week:
- Seasoned 10-Year 3.0s – This coupon has cheapened up during the past week, challenging the overall trend tighter in this sector in recent months as a result of minimal supply and 15-year outperformance.
- Seasoned 15-year 2.5s and 3.0s – The flat yield curve and relative value in these coupons has driven investors to this segment. There continues to be a relatively small pay up over TBA for pools with seasoning between 18 to 36 months. In some cases, investors can potentially receive less price volatility and greater stability of cash flows relative to new pools, for a modest trade-off in projected yield. Please see a recent Strategic Insight discussing the current merits of slightly seasoned, below par 15-year MBS.
- 15-Year 3.5s and 4.0s – New or recently issued pools.
- 20-Year 4.0s – Seasoned pools with WAMs ranging from 190-200, an alternative to new issue 15-year MBS with higher premiums.
- Non-TBA pools – New issue FNMA Relocation 15yr 3.0’s.
- 30-Year 2.5s and 3.5s – Ginnie Jumbo loan collateral (seasoned 2.5s and new production 3.5s)
FNMA DUS and Freddie K’s – The focus for FNMA DUS continues to be on 7-year finals with 5.0% coupons. The trading in Freddie K’s has been on the 4- to 5-year part of the curve. There has also been some renewed interest in Freddie K floaters, as spreads have widened over the past few months and have now reached levels that were last seen back in mid-November 2017. During 2018, the most commonly issued floating rate structures have been the 7-year maturities with 2- or 3-year interest only periods and 10-year maturities with a 5-year interest only period.
Mortgage Rates and Refinance Activity
- Benchmark mortgage rates were largely stable for the week ending 8/17.
- 15-year mortgage rates declined 1bp to 3.79%, 30bps above the 12-month average of 3.49%, and 6bps above the YTD average of 3.73%.
- 30-year mortgage rates slipped 1bp to 4.40%, 27bps above the 12-month average of 4.13%, and 8bps above the YTD average.
- 15-year mortgage rates have increased 59bps in 2018, while 30-year mortgage rates are up 55bps YTD.
Mortgage Applications Continue to Struggle on Higher Rates: Mortgage applications for the week ending August 10 fell 2.0% on a 3.3% decline in purchase applications and unchanged applications for refinance. This marks the fifth weekly decline in purchase apps, matching the longest run since 2009. On a 4w/4w basis, purchase applications are now down 9.5% over the past three months and point to a 7% decline in home sales over the coming months. The 30-year mortgage rate peaked three months ago at 4.86% and has since held near that level, now at 4.81% in the August 10 report.
Housing Starts Disappoint but Permits Offer Hope: July’s housing starts data disappointed expectations, rising just 0.9% after falling 12.9% in June. Economists expected new starts to rebound 7.4%. Starts in the West declined 19.6% and were down 4.0% in the Northeast. On the flip side, new construction increased 11.6% in the Midwest and 10.4% in the South. On a year-over-year basis, starts are now down 1.7% on a 3.0% increase in single family but a 13.3% drop in multi-family. The pace of new housing starts has been choppy, as it always is, but the trends point to a weaker pace of gains led, particularly, by weaker multi-family activity. On a positive note, building permits actually rose 1.5% in July while June’s 2.2% decline was revised up to -0.7%. The only region that saw a month-over-month decline in permits was the South, where they fell 0.3% on a decline in multi-family permits. On a year-over-year basis, permits for new construction are now up 10.8% as single family permits are 12.1% higher, offsetting a 23.9% decline in multi-family.
Homebuilder Confidence Hit an 11-Month Low in August: As expected, the National Association of Homebuilders reported a 1-point decline in its housing market index for the month of August. The headline index moved down to 67 which marked its sixth monthly decline in 2018 and its lowest level in 11 months (64 in September 2017). Residential investment declined in the initial GDP release for 2Q and has dropped in four of the last five quarters. The recent trends in the housing data have drawn attention back to continued strains on affordability from too little supply and higher mortgage rates. The details of Wednesday’s homebuilder report should do little to assuage the concerns that the housing data will remain weak in the coming months. The indexes tracking current sales and those expected six months from now both slipped 1-point. The current sales index fell to an 11-month low while the future sales index edged down to a 21-month low (November 2016). Foot traffic from potential buyers also cooled, with the related index at its lowest level in 10 months.
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG