December 17, 2018
Despite the considerable volatility in risk assets, yield spreads on current production coupons compared to Treasuries were relatively stable during the past week. The new trading range is still being mapped out, but the 2018 basis widening for MBS combined with higher Treasury yields has presented investors with more attractive valuations compared to levels seen in recent years. Yield spreads for 15-year MBS have improved 21 bps during the last year, while spreads on 30-year MBS have expanded 25 bps over the same time period.
Activity has picked up in recent weeks, likely because institutions are preparing their balance sheets for year-end and positioning their portfolios for improved performance. We’ve seen institutions selling odd-lot positions and/or lower yielding securities at a break-even or loss, and using proceeds to purchase higher yielding securities. The timing of repositioning is ideal for many financial institutions as earnings are up considerably in 2018 compared to the previous year, which provides a cushion for absorbing losses.
Last week activity was split almost evenly among the 15-year and 30-year sectors. This is unusual because financial institutions tend to prefer shorter duration pools. However, we are beginning to see select institutions add duration to protect their exposure to declining rate scenarios. 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, but the supply of product is beginning to shrink.
- The most active trade last week was in 15-year 4.0’s. The higher coupons have experienced more widening in recent weeks because of interest rates declining and some premium aversion. We have seen these pools trade at 75 to 80 bps over the Treasury curve based on consensus prepayment speeds. Dollar prices are in the $102 range.
- 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 5 to 6 ticks in front of FHLMC.
- 20-Year – Several trades occurred in seasoned 20-year 2.5’s and 3.0’s at discounted prices. Certain investors 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 –Buyers added both seasoned and new production pools. The new production pools consisted mainly of FNMA 4.0’s and 4.5’s. There was also activity in current production GNMA 4.5’s backed by jumbo loans. The seasoned product was concentrated in high LTV FNMA 3.0’s. The potential for higher turnover in an increasing home price or a decreasing home price environment has attracted buyers to this sector.
- Finally, we saw selected buying in new production relocation pools (FN 3.0’s) that are also assumed to have higher turnover than traditional mortgages.
- FNMA DUS and Freddie K’s – The focus in recent weeks for FNMA DUS has been on 7- to 10-year finals. This has been a popular trade for investors seeking locked-out cash flows.
- Yield spreads on Freddie K’s have widened sharply over the past two months and investors are targeting 3- to 4-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 third consecutive week (12/14).
- 15-year mortgage rates decreased 2bps to 3.92%, which is 10bps above the YTD average of 3.82%.
- 30-year mortgage rates decreased 2bps to 4.57%, which is 13bps above the YTD average of 4.44%.
- Both 15-year and 30-year mortgage rates have increased 72bps in 2018.
Signs of Life in Mortgage Applications: Mortgage applications for the week ending December 7 rose 1.6% on a 2.5% increase in purchase apps and a 1.8% increase in refi apps. The recent pullback in mortgage rates is generating a small bit of mortgage activity. The 4-week moving average for purchase applications has now bounced 9% over the past month.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP