August 24, 2020
The Fed’s aggregate mortgage buying was $25.6bn last week. The most concentrated purchases were in production coupons of UMBS 30-year 2.0s and 2.5s, with volumes of $10.0bn and $6.9bn, respectively. The Fed has purchased approximately $965bn 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, higher prices, and tighter spreads. The average borrower has been the ultimate beneficiary with a large reduction in the cost of mortgage financing.
Current Yield Spreads
Yield spreads on production coupon MBS compared to Treasurys were modestly tighter last week. Spreads on 15-year MBS to Treasurys tightened 4 bps to 45 bps and 30-year MBS narrowed 5 bps to 71 bps. The Fed’s MBS purchases have helped drive spreads tighter 15 to 20 bps this year.
Prepayment concerns and lack of supply continue to be 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 trading activity from last week. We’ve also seen an uptick in investors selling MBS to harvest embedded gains and some repositioning into lower coupons. Selling TBA-eligible MBS remains attractive due to the significant Fed support of liquidity and pricing.
- UMBS 15-year 1.5s to 3.0s (1.5s the most traded)
- UMBS 20-year 2.0s & 2.5s (2.0s the most traded)
- UMBS 30-year 2.0s to 3.5s (2.5s the most traded)
- FNMA Jumbos (FNCK 2.0s to 3.5s)
- GNMA Jumbos (MJM 2.5s)
- 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 decreased slightly last week and remain near historic lows, according to Bankrate.com. The 30-year fixed-rate mortgage decreased 12 bps to 3.02% while the 15-year mortgage rate declined 4 bps to 2.62%. The 30-year mortgage rate has declined 76 bps since the beginning of the year.
The latest data from the Mortgage Bankers Association (MBA) showed mortgage applications slipped last week as purchase applications leveled off and refinance activity continued to be volatile, pulling back 5.4% after spiking 9.3% higher the week before. Purchase applications, however, remained positive inching up 0.8% after a 2.0% gain the week before.
Loan originators widened the primary/secondary spread 5 bps to 1.85% last week. The level remains well over the trailing one-year average of 1.46%. 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. 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