FRM Update

February 22, 2021

Fed Support

The Federal Reserve’s aggregate mortgage buying totaled $24.1bn last week.  The most heavily purchased securities were 30-year UMBS 2.0s and 1.5s with total volumes of $9.8bn and $5.3bn, respectively. The Fed will target up to $61.9bn in MBS from Feb. 12 to Feb. 26. The last cycle saw it target $59.7bn.  The Fed now holds approximately $2.1tn of agency mortgages, or about 29% of the entire universe.

Current Yield Spreads

Current-coupon MBS (15-year 1.5s and 30-year 2.0s) underperformed Treasurys with similar duration last week. Nominal spreads on 15-year MBS to Treasurys widened 18 bps to 56 bps while 30-year MBS widened 7 bps to 85 bps.  The widening in 15-year MBS was the largest weekly move since March 2020.  The sell-off led to solid buying activity from financial institutions as they took advantage of the higher yield opportunity. The spread between 2- and 10-year Treasurys closed at 123 bps last week, the highest level since March 2017.  Financial institutions should benefit from the steeper curve and wider spreads with new purchases. Net interest margin pressure may begin to abate as funding is tied to the well-anchored short end of the curve.

Trading Activity

The summary below reflects purchase activity from the previous week.  Activity was led by UMBS 15-year 1.5s and UMBS 30-year 1.5s.  There was a reduction in purchases of securities with prepayment friction such as NY, LLB, or FL collateral, as investors were more comfortable buying low-coupon on-the-run product due to the sell-off and lower prepayment expectations.

TBA-Eligible Securities:

Non-Deliverable Securities:

Specified Pools:

Given 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/FL collateral, investor loans) to help partially mitigate faster prepay speeds. The graph below highlights monthly prepayment speeds on different collateral types.

Prepay Friction – 30-Year 2.5s of 2020

Mortgage Rates and Applications

The broader bond market sell-off over the past six months has finally started to negatively impact mortgage rates. The 15-year mortgage rate increased 9 bps to 2.43% and the 30-year rate increased 18 bps to 3.04%, according to the weekly survey.  The reduction in the primary/secondary mortgage spread had previously absorbed much of the bond market sell-off.

Mortgage application volume decreased 5.1% during the week ended Feb. 12, according the Mortgage Bankers Association’s survey.  Applications for refinances decreased 5.0% compared with the previous week while applications for purchases decreased 6.0%. Notably, the refinance share of activity dropped to 69.3%, the first time it’s been below 70.0% since October 2020.

The primary/secondary mortgage spread (average 30-year mortgage rate minus 30-year MBS current coupon) declined 6 bps to 1.39%.  The spread has narrowed 64 bps since hitting a high of 2.03% in early March 2020. The narrowing has been due to the mortgage industry dramatically adding headcount to lift capacity constraints.  If volumes decline, the industry might be willing to accept even less profit per loan to sustain revenues and support the recent build in overhead. A reversion to the 5-year average of 1.22% would result in an additional reduction of 14 bps in 30-year mortgage rates.

Michael S. Erhardt, CPA

Senior Vice President, Investment Strategies

Vining Sparks IBG, LP

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