FRM Update

March 25, 2019

The strong bond market rally sent yield spreads on current coupon MBS to Treasuries tighter last week, with 15-year tightening 1 bps to 46 bps, while 30-year tightened 7 bps to 65 bps.  The curve inversion and volatility in the bond market has created some additional opportunities and strategies for investors. Last week we noted that some investors were anxious to deploy excess cash in fear of higher prices and lower yields, while others were able to execute swaps with more favorable pricing for dispositions.

The following represents an overview of the activity in recent weeks:

15-Year MBS

• Current production 15-year 4.0’s are the current favorite within the 15-year sector. Investors concerned about prepayment risk 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.

20-Year MBS

• We’ve seen buying in seasoned and new production pools. Seasoned 2.5’s and 3.0’s at a discount tend to attract investors seeking potential appreciation with declining rates.  Yield buyers have focused more on newer issue pools with less in projected near-term cash flow.

30-Year MBS

• Activity has picked up within this space over the past several months as depositories have focused on adding duration.  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 and relatively low price volatility has been in current production GN II 5.0’s and 5.5’s, trading in the $104-$106 range.  Although this is new production 30-year paper, the projected price volatility is relatively low (ranging from -11.0% to -13.0% with rates up 300 bps), primarily because of the higher coupons and prepayment patterns typically associated with FHA/VA borrowers.
• Other trades included several custom GNMA pools designed to help depositories meet their Community Reinvestment Act (CRA) goals for 2019.

CMBS

• The focus for CMBS (Fannie DUS & Freddie K’s) has generally been on discounted pools with finals in the 7- to 10-year range.  This has been a prevalent trade for investors seeking locked-out cash flow, positive convexity, and higher yields.
• There has also been solid 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 that has occurred during the last few weeks was a new issue FN ACE 11-year final trading at a discount, offering a yield of approximately 3.00%.

Mortgage Rates and Refinance Activity

Benchmark mortgage rates continued their decent last week. 15-year mortgage rates decreased 11 bps to 3.47%, while 30-year mortgage rates declined 14 bps to 4.17%, marking the lowest level in over a year.

Mortgage applications for the week ending March 15 rose 1.6% on a 0.3% increase in purchase apps and 3.5% increase in refi apps. Refi apps have actually increased over the past month, the most convincing uptick since September 2017, as mortgage rates have dropped. Purchase apps remain weak, but have shown a little life rising 4% over the last few weeks.

Housing News:

Home Builder Confidence Unchanged in March: Home builder confidence was unchanged in March, disappointing expectations for a one-point improvement. The NAHB’s Housing Market Index held at 62, a five-month high but down 8 points from a year ago and below levels seen throughout most of 2017 and 2018. The details were mixed with improved sales expectations offset by a cooling in traffic of prospective buyers. The mixed results followed a noisy new home sales report last week showing slower-than-expected January activity that was salvaged somewhat by 63k in positive revisions to the prior three months. Mortgage rates have declined around 0.50% since November, helping ease affordability pressures. The NAHB’s Chairman commented, “Builders report the market is stabilizing following the slowdown at the end of 2018, and they anticipate a solid spring home buying season.”

Michael S. Erhardt, CPA

Senior Vice President, Investment Strategies

Vining Sparks IBG, LP