October 15, 2018
Over the past two weeks yield spreads on current production coupons to Treasuries have sharply widened, as spreads have risen to the widest levels seen over the previous two years. 30-year current coupon spreads versus the Treasury curve are approximately 79bps currently, and have widened 9bps from the close on July 25th.
For the second consecutive week, we have observed investors focusing on 15- and 20-year passthroughs with relatively low coupons. 15-year 2.0s (~150 WAM) trading at a deep discount comprised the bulk of trading activity. These structures are projected to perform well in rising rate scenarios with limited extension risk and stable cash flows. They are also one of the strongest performers across the coupon stack from a LIBOR OAS perspective. We also observed consistent demand for seasoned 20-year 3.0’s and 3.5’s from investors seeking slightly higher yields.
The following represents a summary of the activity last week and themes in the overall sector:
- 10-Year 3.0’s and 3.5’s – Payups are roughly unchanged over the past two months. The strength is largely due to strong bank demand, primarily because of the defensive nature of these structures.
- Seasoned 15-year 2.0s to 3.0s – The flat yield curve and relative value in these coupons has driven investors to this segment. There continues to be a relatively small pay up over TBA for pools with seasoning between 18 to 36 months. In some cases, investors can potentially receive less price volatility and greater stability of cash flows relative to new pools, for a modest trade-off in projected yield. Please see a recent Strategic Insight discussing the current merits of slightly seasoned, below par 15-year MBS.
- Seasoned 20-Year 3.0s and 3.5s – Seasoned pools with WAMs of ~180 have cheapened relative to 15-years in recent months, as the negative net supply of 15-years has caused those spreads to outperform. Seasoned 20-year 3.0’s and 3.5’s were trading only a few ticks back vs 15-year TBA, but they now are trading substantially behind TBA for a similar WAM and superior convexity in some cases.
- FNMA DUS and Freddie K’s – The focus for FNMA DUS last week was on 12-year finals. There was strong demand for Freddie K’s with average lives of 3- to 4-years.
- Custom MBS pools – The MBS desk routinely creates custom MBS pools to assist financial institutions with the Community Reinvestment Act requirements.
Mortgage Rates and Refinance Activity
- Benchmark mortgage rates were slightly lower on the week (10/12).
- 15-year mortgage rates decreased 5bps to 4.02%, 39bps above the 12-month average of 3.63%, and 26bps above the YTD average of 3.76%.
- 30-year mortgage rates decreased 4bps to 4.74%, 49bps above the 12-month average of 4.25%, and 37bps above the YTD average of 4.37%.
- 15-year mortgage rates have increased 82bps in 2018, while 30-year mortgage rates are up 89bps YTD.
Mortgage Applications Dropped 1.7% Last Week: Mortgage applications pulled back 1.7% in the week ended October 5 as new purchase activity slowed and fewer existing mortgagors refinanced their current loans. The decline marked the first week out of the last four that saw a slowdown in overall applications. Purchase applications fell 1.1% and eased in both conventional and government mortgage products. Total refinancing slowed 2.6% and was also weaker across both loan types. With the 30-year mortgage rate moving towards 4.75%, the refinanceable share of the universe has collapsed to approximately 6%, according to research by Nomura.
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG