December 10, 2018
The risk-off sentiment expanded across most markets last week and mortgages were no exception to the selling. Yield spreads on current production coupons underperformed Treasuries by 1 to 2 ticks. However, this was a fairly modest move given the strong bond market rally and selling observed in other fixed-income sectors.
The 2018 basis widening in the MBS market combined with higher Treasury yields has resulted in more attractive valuations, a reduction in extension risk, and prepayment convexity at multi-year lows. Most investors have targeted low duration pools with lower coupons in recent months, but during the past few weeks we’ve seen buying shift away from the 15-year sector and into the 30-year sector. In fact, we saw twice the trading volume in 30-year paper vs 15-year last week; although a healthy portion of the 30-year additions consisted of seasoned product and several trades were in pools backed by jumbo loans.
In terms of activity last week, there was good two-way flow (investors selling and buying). We believe the selling has been spurred on by the bond market rally and investors preparing their balance sheets for year-end and positioning their portfolios for improved performance. Given that some institutions are ahead of their 2018 budget and the fact many portfolios contain securities with book yields below current market yields, attention has shifted to portfolio restructure transactions that have the potential to boost 2019 income. Activity has accelerated in recent weeks, likely because year-end is quickly approaching and institutions are now able to forecast estimated 2018 earnings with a larger degree of certainty.
November fixed-rate prepayment speeds decreased between 8% and 14% for all three of the Agencies. This reverses the uptick seen in October that was more-or-less an outlier due to the extra couple of business days in the month. At this point, to see any meaningful move in prepayment rates would seem to take a fairly meaningful decline in mortgage rates and/or changes in economic conditions. Please see here for the complete November MBS Prepayment Commentary.
The following represents a summary of the activity last week:
- 15-Year – Investors were active in both lower coupons trading at a discount (2.0’s to 3.0’s) and current production coupons (3.5’s and 4.0’s) trading at relatively low premiums. Seasoned 15-year pools, which for much of the year traded in the low-mid 30s on an I-spread basis, have widened out around 8-10 bps since the beginning of October. The pay up over TBA for pools with seasoning between 18 to 36 months remains reasonable.
- TBA pricing for 15-year 3.0’s between FNMA and FHLMC product remains wide versus historical levels. FHLMC normally trades behind FNMA by 1 to 2 ticks because of liquidity differences. Currently, we are seeing FNMA trade 7 to 8 ticks in front of FHLMC.
- 20-Year – Yield buyers have also focused on new production 20-year 3.0’s trading well-below par. 20-year payups have cheapened over the last few weeks due to the yield curve flattening. In addition, the November prepayment report showed 20-year speeds declining in-line with 15’s and 30‘s.
- 30-Year – This sector was the most active last week with buyers adding both seasoned and new production pools. The new production pools consisted mainly of FNMA 4.0’s and 4.5’s trading just over par. There was also activity in current production GNMA 4.5’s backed by jumbo loans. The seasoned product was concentrated in deeply discounted FNMA 2.5’s and 3.0’s backed by jumbo loans.
- FNMA DUS and Freddie K’s – The focus during the past week for FNMA DUS was on 7- to 10-year finals.
- Yield spreads on Freddie K’s have widened sharply over the past two months and investors are targeting 3- to 5-year finals. There has also been steady demand for floating rate structures (FNMA Aces and Freddie K’s in which the fixed-rate cash flow has been swapped out for floating-rate cash flow).
- MBS pools – The MBS desk routinely creates custom MBS pools to assist financial institutions with the Community Reinvestment Act requirements.
Mortgage Rates and Refinance Activity
- Benchmark mortgage rates declined for the second consecutive week (12/7).
- 15-year mortgage rates decreased 2bps to 3.94%, which is 13bps above the YTD average of 3.81%.
- 30-year mortgage rates increased 9bps to 4.59%, which is 17bps above the YTD average of 4.42%.
- Both 15-year and 30-year mortgage rates have increased 74bps in 2018.
Mortgage Applications a Positive Surprise for a Change: Mortgage applications for the week ending November 30 rose 2.0% on a 0.8% increase in purchase apps and a 6.2% increase in refi apps. Purchase apps are now up 13.2% over the last three weeks, the strongest three-week gain since January. While overall applications remain low, the recent uptick has been a welcome surprise for one of the worst-performing sectors in the economy.
Weaker-than-Expected Construction Spending: Construction spending was disappointing with the Census Bureau reporting an unexpected decline for October and making negative revisions to activity in both August (from +0.8% to -0.4%) and September (from 0.0% to -0.1%). Activity dipped 0.1% in October instead of realizing the 0.4% bump economists had expected. Softness in the residential category was no surprise, considering the weakness in the other housing reports of late, and combined with weaker nonresidential spending to offset a recovery in spending on public construction projects. The negative revisions to the final two months of last quarter should affect 3Q GDP in its next revision and the miss for October is likely to weigh some on current quarter estimates. From a broader perspective, the persistent decline in private housing activity is evident in the YoY rate while the trend in the other two categories remains more constructive.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP