July 2, 2018
Mortgages modestly outperformed Treasuries this past week. Current coupon 15- and 30-year MBS yield spreads tightened approximately 2bps to Treasuries. The yield curve continued to flatten this week, opening at 35bps and closing 2bps lower at 33bps. The changing slope of the yield curve combined with a higher short-term rate bias provided steady activity in mortgage-related product for most of the past week.
The average rates on 30-year fixed and 15-year fixed mortgages dipped lower for the week, benefiting from the bond market rally. Meanwhile, mortgage applications decreased from a week earlier, as borrowers contend with affordability due to rising home prices and the lack of housing supply.
Activity last week was primarily focused on the following:
- 10-Year 2.0s and 2.5s – Investors continue to favor discounted 10-year MBS for the incremental spread and shorter cash flow structure, as rates have increased and the yield curve has flattened. Several buyers targeted bonds with lower loan counts in order to take advantage of faster prepayments that could come from seasonal prepayments. 10-year 2.0s and 2.5s prepayments have been elevated in recent months (~14CPR in aggregate last month).
- 15-year 2.5s – This coupon has underperformed most other coupons during the past month or two. The cheapening trend along with the flattening yield curve has resulted in a relatively small pay up over TBA for pools with seasoning between 18 to 36 months. In some cases, investors can potentially receive an outsized reduction in price volatility for a modest trade-off in projected yield. Please see the latest Strategic Insight discussing the current merits of slightly seasoned, below par 15-year MBS.
- 15-Year 3.0s – Remains a favorite among depositories and trading below par.
- Seasoned Relo 15yr 2.5s – Non-TBA pools having various prepayment exceptions, which potentially offer higher turnover.
- FNMA DUS and Freddie K’s – Trading activity in this sector has been modest due to a lack of product in the secondary market and potentially reflecting the fact that the spread between Agency CMBS and pass-throughs has converged closer together. Traditionally, the focus in this sector has largely been on the 3- to 7-year part of the curve, with investors seeking locked out cash flow and positive convexity. However, due to the bond market sell-off, certain discount pass-throughs (~150bps out-of-the-money) offer less negative convexity now and have comparable valuations to Agency CMBS.
Mortgage Rates and Refinance Activity
- Mortgage rates drifted lower for the week ending 6/29.
- 15-year mortgage rates declined 7bps to 3.82%, 44bps above the 12-month average of 3.38%, and 12bps above the YTD average of 3.70%.
- 30-year mortgage decreased 6bps to 4.39%, 33bps above the 12-month average of 4.06%, and 10bps above the YTD average.
- 15-year mortgage rates have increased 62bps in 2018, while 30-year mortgage rates are up 54bps YTD.
Mortgage Applications Post Largest Drop in Four Months: Total mortgage applications fell 4.9% for the week ending June 22, even though mortgage rates were largely stable. There were 12.0% fewer applications compared with the same week one year ago. The decline was led by a 6.0% reduction in applications for a home purchase, while the refinance index declined 3.5% from the previous week. The refinancing index remains near a 10 year low. At current levels, nearly 90% of the mortgage market is practically out of the refinancing window. The remaining refinancing business is primarily cash-out activity, which has accounted for nearly 70% of recent refinancings.
New Homes Sold at the Second Strongest Pace of the Cycle: New homes sold at their second fastest pace of the cycle in May on a flurry of contract signings in the South. Sales totaled 689k annualized units last month, second only to last November’s 712k-unit pace. While the pace was surprisingly strong, a regional concentration of activity reflected a more narrow improvement. Sales in the Northeast (5% of volume) dropped 10.0% while activity in the West (23% of volume) fell 8.7% and contract signings in the Midwest (13% of volume) were unchanged. But those disappointments were overwhelmed by a 17.9% surge in the South (59% of volume), the largest monthly gain since December 2014. The brisk sales pace dropped months’ supply on hand to 5.2 months, the lowest since last November. But encouragingly for potential buyers, pricing cooled. The median sales price fell on a year-over-year basis for the first time since April 2017 to its lowest level ($313k) since that same month. New home sales have been the bright spot for the sector as existing home sales have languished, and other metrics within the May report showed this may continue to be so. New homes sold but not started rose to the second strongest level since 2007.
Pending Home Sales Point to Continued Struggles for Existing Homes Transaction: Pending home sales fell for a second month in May and have now missed estimates in five of the last six reports. Total pending sales slipped 0.5% in May because of a large 3.5% pullback of activity in the South, where existing sales account for roughly 40% of total activity. The other three regions that drive the remaining 60% of volume actually saw activity improve. Contract signings rose 2.0% in the Northeast, rebounded 2.9% in the Midwest, and edged 0.6% higher in the West. Stepping away from the monthly changes which tend to be noisy, the prognosis for future existing homes sales remains downbeat. Non-seasonally adjusted pending sales on a year-over-year basis have declined in 10 of the last 17 months. And looking at the seasonally adjusted index, pending sales have been in a clear downtrend since peaking in 2016. The NAR’s chief economist said, “Realtors in most of the country continue to describe their markets as highly competitive and fast moving, but without enough new and existing inventory for sale, activity has essentially stalled.”
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG