August 31, 2020
By the end of this week the Fed will have purchased over $1tn of agency MBS since resuming QE in mid-March. For context, total net issuance from 2017 through 2019 was $893bn. 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 tighter last week. Spreads on 15-year MBS to Treasurys tightened 5 bps to 40 bps and 30-year MBS narrowed 1 bp to 70 bps. The Fed’s MBS purchases have helped drive spreads tighter 20 to 22 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 a noticeable 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 2.5s (2.5s the most traded)
- UMBS 20-year 1.5s & 2.0s (2.0s the most traded)
- UMBS 30-year 2.0s to 3.0s (2.5s the most traded)
- FNMA Jumbos (FNCK 2.0s & 2.5s)
- 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 were mixed last week and remain near historic lows, according to Bankrate.com. The 30-year fixed-rate mortgage increased 11 bps to 3.13% while the 15-year mortgage rate declined 3 bps to 2.59%. The 30-year mortgage rate has declined 65 bps since the beginning of the year.
Mortgage applications for the week ending August 21 fell 6.5% on a 10.2% decline in refi apps but a 0.4% uptick in purchase apps. While the pace of gains in purchase apps has slowed in recent weeks, they continue to point to an improving housing market.
Loan originators tightened the primary/secondary spread 16 bps to 1.69% last week. The level remains over the trailing one-year average of 1.47%. More importantly, the trailing five-year average is 1.19%, therefore, mortgage rates have plenty of room to decline further if we see a reversion in the primary/secondary spread.
Last week the Federal Housing Finance Agency (FHFA) announced it is delaying the date it will begin implementing its adverse market refinance fee of 50 bps to December 1, 2020. The refinance fee was previously scheduled to take effect September 1, 2020. FHFA also announced that the adverse market refinance fee will not apply to refinance loans with loan balances below $125,000.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP