July 6, 2020
Fed Intervention and Yield Spreads
Since March 16, 2020 the Fed has purchased just shy $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 March 13. Since that time the Fed has purchased $22.3bn, $211.6bn, and $166.9bn, respectively.
Current Yield Spreads
Nominal spreads for production MBS to Treasurys were tighter on a week-over-week basis. 15-year tightened 8 bps to 65 bps and 30-year tightened 11 bps to 100 bps. Despite the recent bout of tightening nominal spreads are higher on a year-over-year basis by approximately 18-20 bps.
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 8 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. 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 2.5s)
- FNMA Jumbos (FNCK 3.0s & 3.5s)
- Specified pools with low loan balances that offer potential prepayment protection as borrowers have less incentive to refinance
- UMBS 15-year 2.0s to 2.5s
- UMBS 20-year 2.0s and 2.5s
- UMBS 30-year 2.0s and 3.0s
Mortgage Rates and Refinance Activity
Mortgage rates continued to drift lower last week and remain near historic lows. According to Bankrate.com, the 15-year decreased 3 bps to 2.76% while the 30-year fell 5 bps to 3.25%. In another prominent survey, Freddie Mac reported that the 30-year fixed-rate mortgage in its survey ending July 2 fell to 3.07%, the lowest rate in the survey’s history, dating back to 1971.
Mortgage applications for the week ending June 26 were soft for a second week in a row despite mortgage rates falling to a new record low. Total applications fell 1.8% on a 1.3% decline in purchase apps and a 2.2% drop in refi apps. Despite the disappointing results for the reference week, purchase applications remain 19% higher than they average in 2019 while refis remain 93% higher.
Lenders have the primary/secondary spread at 1.72%, well above its trailing one-year average of 1.34%, 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