October 26, 2020
The Fed’s aggregate mortgage buying last week was $26.8bn. The most heavily purchased was 30-year UMBS 2.0s and 2.5s with volumes of $12.3bn and $5.9bn, respectively. The newest schedule shows the Fed will target $58bn in purchases from October 15 to October 28. 30-year UMBS 1.5s are not included in the planned purchases.
Current Yield Spreads
Yield spreads on production-coupon MBS compared to Treasurys with similar duration were mixed last week. Nominal spreads on 15-year MBS to Treasurys tightened 1 bp to 52 bps and 30-year MBS widened 4 bps to 89 bps. Lower coupons such as 30-year 2.0s and 15-year 1.5s performed better than higher coupons, as investors are likely anticipating the Fed will eventually reduce purchases in higher coupons.
Prepayment risk is the primary concern for MBS investors as prices remain high from Fed action to support borrowers.
To help mitigate prepayment risk MBS buyers have favored lower coupons and pools with characteristics that dampen prepayments (low loan balances, 100% NY, 100% FL, low FICOs, investor loans).
The summary below reflects trading activity from last week, which was led by 15-year 1.5s and 30-year FNMA Jumbo 2.0s. Trades consisted primarily of bonds going out to customers, but we’ve also seen depositories selling MBS to monetize unrealized gains to supplement earnings and capital ratios. Proceeds have generally been reinvested into MBS with lower coupons or collateral that has prepayment friction.
- UMBS 10-year 1.5s
- UMBS 15-year 1.5s to 3.5s (1.5s the most traded)
- UMBS 20-year 1.5s to 2.5s
- UMBS 30-year 1.5s to 2.5s (1.5s the most traded)
- FNMA Jumbos (FNCK 1.5s to 3.0s)
- 15- and 30-year 1.5s to 3.0s LLB Pools ($85k -$200k max loan size)
- Custom CRA Pools
Given robust refinance activity, portfolio managers continue to seek prepay protection to avoid potentially low or negative yields. Many investors have turned to specified pools (lower loan balances, NY/FL collateral, investor loans) to help partially mitigate faster prepay speeds. The graph below highlights monthly prepayment speeds on different collateral types.
Mortgage Rates and Refinance Activity
The 30-year fixed-rate mortgage decreased 1 bp to 3.03% while the 15-year mortgage rate increased 1 bp to 2.58%, according to Bankrate.com. In a separate survey by Freddie Mac, which includes points/fees, the 30-year rate decreased 1 bp to 2.80%, another record low and well below the 3.75% level from one year ago.
Mortgage applications for the week ending October 16 fell 0.6% on a fourth consecutive weekly decline in purchase apps. Applications for refinance rose 0.2% on the week but have remained rangebound over the last two months. After declining 2.1% for the week, purchase apps are now down 6.8% over the past four weeks.
The primary/secondary mortgage spread (average 30-year mortgage rate minus 30-year MBS current coupon) dropped 4 bps last week to 1.56%. The current level is 1 bp over the trailing one-year average of 1.55% and 35 bps over the trailing five-year average of 1.21%. Therefore, mortgage rates could still fall if we see a reversion in the primary/secondary spread, even if Treasury yields remain stable.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP