May 18, 2020
Fed Intervention and Yield Spreads
The Fed has purchased over $600bn of agency MBS as part of its effort to stabilize the sector. The buying has been focused on the 30-year pools with lower coupons. To put the scale of buying into context, during the sums of QE1 in 2008/2009 and QE3 in 2012/2013, the Fed bought about $1.4tn of mortgages; each of these episodes took over a year to complete. The Fed’s total holdings of agency MBS is estimated to be $2.0tn, which is approximately 30% of the $6.7tn market. The Fed will likely own 40% of the agency MBS universe by year-end.
Pool level details are listed below on the $177bn of conventional 30-year that the Fed purchased for May settle (5/13), which was an increase of $62bn over April. The Fed received $86.3bn in 2.5s, $59.9bn in 3s, $14.6bn in 3.5s, $13.5bn in 4s, and $2.4bn in 4.5s. 30-year 2.5s and 3.0s accounted for 83% of the purchases.
The Fed has gradually lowered its planned purchases since the start of QE4. The daily total of mortgage purchases has been reduced from a peak of ~$50bn/day to a planned ~$4.5bn/day this week.
The historic level of Fed purchases has significantly reduced price and spread volatility in the sector. Prices have been pushed far higher and spreads have narrowed from distressed levels. For example, 2019-production 30-Year 2.5 MBS have increased in price by approximately 4 points (from $100 to $104) from lows in mid-March. 2019-production 15-Year 2.0 MBS have increased in price by approximately 3.5 points (from $99.5 to $103) from lows in mid-March.
Nominal spreads for production MBS to Treasurys were mixed on a week-over-week basis, with 15-year tightening 2 bps to 73 bps and 30-year widening 10 bps to 114 bps. Most of the widening in 30-year happened in 2.5s (8+ wider) and 3.0s (10+ wider) as the Fed moved down in coupon and increased purchases in 2.0s (2+ wider).
Investor Trading Activity
There was decent two-way flow in trading activity last week with customers buying and selling securities. The theme in the sector continues to be financial institutions selling TBA-deliverable MBS as the Fed’s massive QE has inflated prices. Reinvestment and new purchase activity have been focused what the Fed isn’t buying, including non-deliverable MBS and other sectors with wider spreads.
Since the Fed’s buying program does not include non-deliverable MBS securities, spreads are wider in this space. We’ve seen buying activity in GNMA 15-year pools, and both GNMA (MJM 2.5s) and conventional pools (CK 2.5s) collateralized by jumbo loans. There’s also been steady buying in new production 15-year 2.0s and 20-year 2.0s. Investors seem to be targeting the lowest coupons in each product category.
Finally, we are seeing customers consider MBS and CMOs backed by collateral that minimizes the opportunity for a borrower to refinance. These include low loan balances and pools with favorable geographies. For instance, 100% New York pools are known to prepay slower than similar collateral due to higher taxes in NY on mortgages, raising the fixed cost to refinance.
Mortgage Rates and Refinance Activity
Mortgage rates were mixed last week as 15-year decreased 19 bps to 2.93%, while 30-year increased 1 bp to 3.52%. Refinance activity decreased 3.3% for the week ending May 8, according to the Mortgage Bankers Association. The index has declined 7 out of the last 10 reports and has dropped 42% since hitting a YTD high on March 6. The purchase index rose 10.6%.
Mortgage lenders have the primary/secondary spread at 1.92%, well above its trailing one-year average of 1.24%, in order to manage risk; it hit 2.33% on March 27, the highest in at least a decade. The spread could begin to narrow though, 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%, in what appears to be a bid to expand market share. 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.
We recently published a Strategic Insight addressing mortgage rates and prepayment speeds. It is loaded with thoughtful insight into the current market and highlights several things to consider for MBS investors. Please see here for a copy.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP