March 11, 2019
Yield spreads on current coupon MBS to Treasuries were mixed last week with 15-year widening 2 bps to 50 bps, while 30-year tightened 2 bps to 73 bps.
Depositories continue to be active in the MBS space with the bulk of activity being in the 15- and 20-year sectors, across nearly all coupons. The following represents a summary of the activity we’ve seen in recent weeks:
- Current production 4.0’s and 4.5’s continue to be the most prominent trade in the 15-year sector. Premium reluctant buyers have steered towards 3.0’s or 3.5’s.
- Lower coupon pools such as 15-year 2.0’s and 2.5’s have also been in demand and are generally being traded at a discount. These seasoned pools tend to have less negative convexity and exhibit better projected performance in a declining rate environment versus higher coupons.
- We’ve seen buying in both seasoned and new production pools. Most of the activity has been in current production 4.0’s. Seasoned 2.5’s at a discount tend to attract investors seeking potential appreciation with declining rates.
- Activity has picked up within this space over the past several months as depositories have focused on adding duration in order to address declining rate exposure. Tax reform and basis tightening in Municipals has also led some investors to consider longer term MBS. A recent Strategic Insight on this topic can be found here.
- An active trade for investors seeking potentially higher yields has been in current production GN II 5.0’s and 5.5’s.
- Other trades included several custom GNMA pools designed to help depositories meet their Community Reinvestment Act (CRA) goals for 2019.
- The focus for CMBS (Fannie DUS & Freddie K’s) has generally been on discounted pools with finals in the 7-year range. This has been a prevalent trade for investors seeking locked-out cash flow, positive convexity, and higher yields.
- There has also been steady demand for floating rate structures (Freddie K’s and FN ACES in which the fixed-rate cash flow has been swapped out for floating-rate cash flow). A prevalent trade last week was a new issue FN ACE 11-year final trading at a discount, offering a margin of +32 bps to 1-month LIBOR.
Mortgage Rates and Refinance Activity
Benchmark mortgage rates grinded lower last week. 15-year mortgage rates decreased 3 bps to 3.67%, while 30-year mortgage rates decreased 12 bps to 4.31%, remaining near the lowest level in a year.
Mortgage applications for the week ending March 1 fell 2.5% on a 2.5% decline in purchase apps and a 2.0% drop in refis. According to the MBA data, mortgage applications were fractionally higher during the observation period. Looking at the 4-week moving averages, purchase applications have now given up their January to early-February gains.
Housing Starts and New Permits Provide More Signs of Life for Housing Market: Housing starts and building permits were both better than expected in January. Housing starts were up 18.6% in January while December 11.2% estimated decline was revised to an even-worse 14.0%. Single family starts roared back while multi-family just ticked higher. Building permits also topped estimates with a 1.4% MoM improvement, as another solid month for multi-family offset a second month of weakness in single family interest.
Construction Spending Contracted Unexpectedly on Weaker Residential Results: The housing slowdown hurt overall construction spending in December , with the total value spent on new construction projects down 0.6% (expected +0.1%) in the final month of 2018. Private residential spending dropped 1.4% in December while public outlays for housing were down 5.1%. The weaker residential activity in the private sector was the result of a 3.2% pullback in single family homes activity and a modest 0.4% dip in home improvement spending. The decline in home improvement activity followed a 12.7% surge in November, the largest since 1998. Away from housing, private spending on non-residential buildings was up 0.4% (strong month for lodging, restaurants, health care, communication, and manufacturing) while related spending in the public sector dipped 0.6% (weak month for transportation-related categories). The disappointment in December’s construction spending falls in line with a long list of economic reports that reflect a slowdown at the end of 2018 amid heightened uncertainty.
December’s New Home Sales Were Better than Expected But 2018’s Total Was Hit by Negative Prior Revisions: New home sales closed out 2018 at a better-than-expected pace in December, although total activity for 2018 was a bit softer after 75k in downward revisions to the prior three months’ sales. New homes sold at a 621k unit annualized pace in December, better than the 600k economists had expected, representing a 3.7% increase from November. November’s 16.9% estimated surge was revised to a less-spectacular 9.1% gain. Total sales rose 5% in the South and 1.4% in the West, the two regions with the greatest volumes. There were offsetting swings in the smaller Northeast and Midwest. Based on the current data, which is still subject to revision, total sales rose 0.9% in 2018, the slowest pace since 2011. The median price rebounded 5% in December to $318,600 but remained down 7.2% from a year ago. Months’ supply dipped to 6.6 months but remained elevated above 2017’s average of 5.4. Amid continued weakness in the housing data, there have been some signs that lower rates and slower price gains may be starting to have a positive effect on demand. Purchase applications have firmed up with mortgage rates back near 12-month lows and pending home sales broke a string of nine months of weaker activity in January.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP