June 18, 2018
Mortgages outperformed Treasuries and swaps this past week, as 15-year MBS yield spreads ended the week 3bps tighter to Treasuries, while 30-year MBS yield spreads tightened 1bp. The yield curve continued to flatten last week with the 2/10s spread narrowing from 44bps to just 37bps at the close on Friday. This trend has been a tailwind for the MBS sector as investors have sought defensive structures that provide near-term cash flow.
Activity last week was primarily focused on the following:
- 15-year 2.5s – This coupon has underperformed most other coupons over the past month. 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.
- 10-Year 2.5s and 3.0s – Have been consistent choices among investors seeking protection from higher market rates, as these structures provide high-scheduled cash flow regardless of the rate environment.
- Seasoned Relo 15yr 2.5’s s – 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 non-agency CMBS.
- CMO activity picked up versus the week prior.
- Inquiries for VADM and PAC structures often gravitated toward sequentials, as the pickup in yield comes with a relatively small stability sacrifice depending on the collateral.
- Recent sequential issuance included a variety of coupon cuts off a variety of collateral types, and while financial institutions comprised the lions share of buyers last week, not all sought the same bond profiles.
- Most purchases represented redeployment of cash as opposed to swapping and repositioning.
Mortgage Rates and Refinance Activity
- Mortgage rates were largely unchanged for the week ending 6/15.
- 15-year mortgage rates held firm at 3.89%, 54bps above the 12-month average of 3.35%, and 20bps above the YTD average.
- 30-year mortgage decreased 3bps to 4.43%, 40bps above the 12-month average of 4.03%.
- 15-year mortgage rates have increased 69bps in 2018, while 30-year mortgage rates are up 58bps YTD.
Mortgage applications pulled back in the week ended June 8 after rising for the first time in seven weeks in the prior release. Total applications pulled back 1.5%, matching the decline in both purchase and refi requests. Interest in fixed-rate products fell 1.1%, while activity in adjustable-rate offerings dropped a larger 6.4%. Conventional mortgage applications slowed 3.4% from a prior-week rebound, while interest in government-backed loans rose 5.7%.
This past week, FHFA announced its proposal for capital requirements for Fannie and Freddie. The plan would replace the current $3bn in capital for each GSE with a more comprehensive risk-based approach, while putting a floor on overall capital. The FHFA presented two options for capital. The first represented 2.5% of the companies’ total assets and off-balance sheet guarantees, which was ~$140bn based on their 2017 book of business. The second option was 1.5% of the companies’ trust assets and 4% of their non-trust assets, which would have been ~$104bn. The FHFA said the options would have protected each company during the financial crisis if they had been subject to the rule in 2007. More details can be found here.
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG