June 15, 2020
Fed Intervention and Yield Spreads
Over the past three months, the Fed has purchased ~$725bn of agency MBS as part of its effort to stabilize the sector. The buying has been focused on the 30-year pools with lower coupons. The daily total of mortgage purchases has been reduced from a peak of ~$50bn/day to ~$4.5bn/day. The Fed purchased $22.7bn last week, of which the UMBS 2.5% for July settle totaled $9.3bn and the G2SF 2.5% for July settle totaled $3.4bn. The central bank promised Wednesday that “over coming months the Federal Reserve will increase its holdings of Treasury securities and agency residential and commercial mortgage-backed securities at least at the current pace”. This puts the monthly floor at approximately $40bn for RMBS.
The historic level of Fed purchases has significantly reduced price and spread volatility in the sector. The feverish pace of the Fed support in March brought spreads from the wides that rivalled the level reached in 2008/2009. Nominal 30-year mortgage spreads to Treasuries touched a stressed level of almost 150 bps. Within a week of Fed’s intention to purchase up to $50bn per day of agency MBS, spreads came in to 75 bps.
Nominal spreads for production MBS to Treasurys were mixed on a week-over-week basis. 15-year widened 2 bps to 68 bps and 30-year tightened 3 bps to 105 bps. The tightening was more prevalent in higher coupons, likely in part by the Fed’s promise to continue to buy mortgages at least at the current pace.
Investor Trading Activity
Financial institutions continue to be active investors as it’s become punitive to hold excess cash as deposit rates generally exceed the Fed Funds rate. There is also some concern that yield spreads may begin to tighten as supply in many sectors is challenged.
The major positive for the sector is the Fed’s buying of agency MBS. The main concerns from investors are prepayment speeds and supply.
There was broad-based trading activity last week with customers buying securities. 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.
Last week activity included the following:
- GNMA Jumbos (MJM 2.5s to 3.5s)
- FNMA Jumbos (FNCK 2.0s to 3.5s)
- UMBS 15-year 1.5s and 2.5s (new production)
- UMBS 20-year 2.0s and 2.5s (new production)
Mortgage Rates and Refinance Activity
Mortgage rates declined last week, with the 30-year rate falling 13 bps to 3.39% and the 15-year declining 2 bps to 2.85%. Refinance activity increased 11.4% for the week ending June 5, according to the Mortgage Bankers Association. It is the first increase seen since April 10. The purchase index rose 5.3% and has risen for eight straight weeks to its highest since Jan. 24.
Lenders have the primary/secondary spread at 1.76%, well above its trailing one-year average of 1.29%, in order to manage risk. Still, it is at its tightest spread since April 24. The spread could begin to 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