FRM Update

August 7, 2017

Mortgage yield spreads were slightly tighter last week and activity was generally slow as the curve flattened 3bps (2s to 10s) and 10-year Treasury yields moved a couple of basis points lower after several disappointing economic reports. Mortgage rates moved lower and mortgage application activity slowed last week. MBS prepayment speeds slowed in July and day count was the main driver behind the decrease. For most portfolio managers, July prepayment speeds should represent a status quo for mortgage-related securities holdings. August MBS prepayments are expected to increase due to an increase in day count. For additional prepayment commentary and charts, please see our July Prepayment Commentary. Housing reports were mixed with pending homes sales rising 1.5%, while construction spending fell 1.3% MoM.

MBS

• Mortgage yield spreads tightened last week:
  • 15-year and 30-year MBS yield spreads ended the week 1 to 2bps tighter to Treasuries and swaps
• Curve slope measured by 2- and 10-year Treasuries flattened 3bps last week from 94 to 91bps.
• Investors were active last week in newer production 15yr MBS, primarily in 2.5% coupons and in newer production 20yr MBS with 3.5% coupons.
• Investors were also active in seasoned 20yr MBS, primarily in 2.5% and 3% coupons and in seasoned 30yr MBS with 3.5% coupons.
• A combination of higher yield versus agency bullets and deference to convexity inspired activity in multi-family FNMA DUS with 7yr maturities, and in uncapped floating rate Freddie K’s, taking advantage of higher yield opportunities in LIBOR rates.

CMOs

Trading activity in CMOs was on the slower side and yield spreads in CMOs were generally unchanged last week. Depositories were focused on stable structures with 4- to 6-year average lives.

• Full coupon front sequential structures off of 30yr 3.0% and 30yr 3.5% collateral (“3.5 squared”) remained popular with financial institutions with wider spreads and better supply than many shorter structures.
• Investors were also active in VADM’s, offering extension protection from structure and shorter stated final maturities.

Rates and Refis

• Mortgage rates fell last week.
  • 15-year mortgage rates fell 3bps to 2.99%
  • 30-year mortgage rates fell 4bps to 3.81%
• 15- and 30-year fixed mortgage rates have now fallen 25bps year-to-date; however; mortgage rates are 32 and 42bps higher than this time last year.
• The last four months thirty-year mortgage rates have averaged 3.86%, according to Bankrate, with the high and low being only 0.25% apart. Fifteen-year mortgage rates have averaging 3.06% with the high and low only being 0.18% apart. Mortgage holders have had limited interest rate incentive to refinance for some time.
• Mortgage applications for the week ending July 28 fell 2.8% as purchase apps fell 2.0% and refi apps fell 3.8% to 1361 in the MBA Refi Index. Refinance activity remains at historically low levels and the Refi Index reveals that burnout dominates an unincentivized population of mortgage holders this year.

July Prepayment Speeds

July prepayments contained no surprises, decreasing for all three agencies. Day count was the main driver behind this decrease: July contained two less business days than June. Adjusting for day count, July prepayment numbers reverse the increases observed last month. Newer and slightly seasoned MBS slowed much less than more seasoned collateral, especially seasoned, higher-coupon collateral. For most portfolio managers, July prepayment speeds should represent a status quo for mortgage-related securities holdings. August MBS prepayments should increase 15% based on an increase in day count; however, a weak housing market and seasonal factors will likely result in a less than 15% increase in prepayments. For additional prepayment commentary and charts, please see our July Prepayment Commentary.

Housing

Pending Home Sales Beat Expectations in June, Remain Choppy:  June’s Pending Home Sales report beat expectations of a 1.0% gain, growing 1.5%. Pending sales were notably strong in the West (+2.9% MoM) and the South (+2.1%). On a year-over-year basis, pending sales in the Northeast and South have been the strongest rising 2.9% and 2.6%, respectively. Based on the pending sales report, it appears that existing home sales are likely to be flat in July with strength in the South and West offset by weakness in the Midwest.

Construction Spending Disappoints, Could Detract in 2Q GDP Revisions:  June’s construction spending data was much weaker than expected, falling 1.3% MoM, and a slight positive revision to May’s data was offset by a much larger negative revision to April’s results. The net effect is likely to be a modest negative revision to 2Q growth. The biggest drop occurred in public construction spending, which fell 5.4% from May. Multifamily activity drove the disappointment in private residential spending and offset a modest gain in spending on single family residences.

Dan Stimpson, CPA

Senior Vice President

Vining Sparks