June 22, 2020
Fed Intervention and Yield Spreads
Since mid-March the Fed has purchased over $750bn of agency MBS as part of its QE4 program. The buying has generally been focused on the 30-year pools with lower coupons. The Fed owned 21% of the mortgage market at the start of 2020, its share is expected to increase to over 35% by year-end.
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. The Fed purchased $22.9bn last week, of which the UMBS 2.5% for July settle made up 41% of all buying. The UMBS 30-year 2% for July settle was the second-most purchased, comprising just shy of 17% of all buying.
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 widest levels since 2008/2009. 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.
Nominal spreads for production MBS to Treasurys were wider on a week-over-week basis. 15-year widened 11 bps to 79 bps and 30-year widened 9 bps to 114 bps. The widening was more prevalent in higher coupons, as investors continue to have concerns about prepayments.
Investor Trading Activity
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 10 bps on excess cash/reserves is punitive to earnings. There is also some concern that yield spreads may begin to tighten as supply in many sectors is challenged.
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, last week there was 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 to 3.5s)
- FNMA Jumbos (FNCK 2.0s to 3.5s)
- UMBS 15-year 1.5s to 2.5s (new production)
- UMBS 20-year 2.0s and 2.5s (new production)
- UMBS 30-year 2.0s and 2.5s (new production)
Mortgage Rates and Refinance Activity
Mortgage rates were stable last week, with both the 15- and 30-year rates increasing just 1 bp to 2.86% and 3.40%, respectively. Refinance activity increased 10.3% for the week ended June 12, according to the Mortgage Bankers Association. It is the second weekly increase in a row. The purchase index rose 3.5% and has risen for nine straight weeks to its highest since January 2009. The refi index remains elevated as consumers take advantage of historically low interest rates.
Lenders have the primary/secondary spread at 1.76%, 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