June 29, 2020
Fed Intervention and Yield Spreads
Since March 16, 2020 the Fed has purchased an astonishing $765bn 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’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 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 slightly tighter on a week-over-week basis. 15-year tightened 6 bps to 73 bps and 30-year tightened 3 bps to 111 bps. The higher coupons didn’t fare as well as investors continue to grapple over potential 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 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 couple of 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 2.0s to 3.0s)
- FNMA Jumbos (FNCK 2.0s to 3.5s)
- GNMA 15-year 3.0s to 3.5s
- Specified pools with low loan balances that offer potential prepayment protection as borrowers have less incentive to refinance
- UMBS 15-year 1.5s to 2.5s
- UMBS 20-year 2.0s and 2.5s
- UMBS 30-year 2.0s and 3.5s
Mortgage Rates and Refinance Activity
Mortgage rates declined meaningfully last week and remain at historic lows. The 15-year decreased 7 bps to 2.79% while the 30-year fell 10 bps to 3.30%. Refinance activity dropped 11.7% for the week ended June 19, according to the Mortgage Bankers Association. The previous week saw it rise 10.3%. The purchase index fell 3.0%, ending a streak of nine straight weeks of increases that sent it to its highest since January 2009.
Lenders have the primary/secondary spread at 1.72%, 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