July 13, 2020
Fed Intervention and Yield Spreads
The Fed’s aggregate mortgage buying last week was $22.8bn. The most heavily purchased was the UMBS 30-year 2.50% for August settle. Since March 16, 2020 the Fed has purchased over $800bn of agency MBS as part of its QE4 program. The Fed’s initial daily total of mortgage purchases was up to ~$50bn/day but the purchases have been tapered down to ~$4.5bn/day currently. At the June FOMC meeting officials stated the Fed will purchase a minimum of $40bn per month until financial conditions improve.
The historic level of Fed support has significantly increased pricing and reduced spread volatility in the sector. Nominal 30-year mortgage spreads to Treasurys touched a stressed level of almost 150 bps. Within a week of announcing the Fed’s intention to purchase up to $50bn per day of agency MBS, spreads came in to 75 bps. In terms of pricing, the UMBS 30-year 2.0%, 2.5% and 3.0% have risen 5.0, 3.5 and 3.5 points, respectively, since mid-March.
Current Yield Spreads
Nominal spreads for production MBS to Treasurys were tighter on a week-over-week basis. 15-year tightened 8 bps to 57 bps and 30-year tightened 10 bps to 90 bps. Nominal spreads are wider on a year-over-year basis by a few basis points. Z-spreads have recovered from their recent lows.
Financial institutions continue to be active investors as cash and deposits have piled up at an unprecedented pace and pressure to put them to work is building. Earning just 5 to 10 bps on excess cash/reserves is punitive to earnings. There is also some concern that yield spreads may begin to tighten as supply is challenged thanks to the Fed.
Over the past few months, new purchase activity has been focused on what the Fed isn’t buying (non-deliverable MBS securities), as these products generally offer wider spreads vs TBA-eligible securities with rich valuations. However, in the past several weeks there’s been an uptick in buying of deliverable securities, as the pay-up for enhanced liquidity has narrowed.
Last week activity included the following:
- GNMA Jumbos (MJM 2.5 qs)
- FNMA Jumbos (FNCK 2.0s to 3.5s)
- UMBS 15-year 1.5s to 3.0s
- UMBS 20-year 2.0s and 4.5s
- UMBS 30-year 2.0s and 4.0s (most volume of any sector)
- 30-Year 2.5% LLB Pools ($150k max loan size)
- 15-Year 2.5% LLB Pools
- Custom CRA Pools
Mortgage Rates and Refinance Activity
The June prepayment report showed another month of accelerating prepayments on a broad basis. In aggregate, Fannie 30-year speeds printed at 32.5 CPR, and increase of 3.3 CPR, or 11% over the prior month. Fannie 15-year paid at 21.1 CPR in aggregate, increasing 3.1 CPR, or 17% from the previous month. Higher speeds were driven by lower mortgage rates (refi activity), a rebound in turnover, and a higher day count. The upside to faster prepayment speeds is the increase to Fed paydowns, which will increase gross purchases and offer price support. Please see here for the complete prepayment commentary.
Mortgage Rates and Refinance Activity
Mortgage rates drifted lower last week and hit another record low. According to Bankrate.com, the 15-year decreased 3 bps to 2.72% while the 30-year fell 5 bps to 3.20%. In another prominent survey, Freddie Mac reported that the 30-year fixed-rate mortgage in its survey ending July 9 fell to 3.03%, the lowest rate in the survey’s history, dating back to 1971. The 15-year rate dropped to 2.56%, the lowest since May of 2013.
Mortgage applications for the week ending July 3 rose 2.2% on another gain in both purchase and refi apps. Purchase applications rose 5.3% bringing them to up 25.6% versus the 2019 average. Refi apps inched up 0.4% during the week, now up 94% from the 2019 average. The housing data look strong in the short term. The longer-term challenge will be its resilience once the household income supplements have expired.
The primary/secondary spread at 1.74%, well above its trailing one-year average of 1.29%, in order to manage risk. The spread could narrow further, as United Wholesale Mortgage (UWM), which holds nearly a third of the market share in wholesale mortgage lending, is now offering its brokers the ability to offer borrowers 30-year fixed-rate loans as low as 2.5%. This could have a meaningful impact on refinance activity if other brokers follow UWM’s lead. Investors should continue to use caution when considering higher coupons and larger premiums.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP