September 10, 2018
Yields spreads for current production coupon MBS to Treasuries were essentially unchanged for the week. However, yield spreads are wider by 4-5bps over the past few weeks and have reached close to the widest levels of the year, despite implied volatility remaining stable and prepayments behaving in a tame fashion. The cheapening trend in 2018 has been meaningful, with yield spreads on 30-year MBS widening by 17bps and spreads on 15-year widening by 13bps.
Investor activity over the previous week was largely focused on seasoned 15- and 20-year MBS with lower coupons trading at a discount. Seasoned 15-year 3.0s (WAM of ~130) accounted for a sizeable share of total activity with investors taking advantage of a modest pay up for seasoning and predictable cash flow. 10-year MBS issuance has been relatively muted this year and spreads remain somewhat tight. As a result, we’ve seen certain investors seek highly seasoned 15-year MBS as a substitute.
The August prepayment report was released late last week. Overall MBS prepayments accelerated slightly during August. A favorable day count and seasonal factors such as housing turnover pushed prepayments forward into the headwind of slightly higher mortgage rates and their suppressive impact on refinance activity. The complete commentary can be found here.
The following represents a summary of the activity last week and themes in the overall sector:
- Seasoned 15-year 2.5s and 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.
- 15-Year 3.5s and 4.0s – 15-Year 4.0s are trading at relatively low premiums (~$103.00) and offer a projected yield spread to Treasuries of approximately 50bps.
- Seasoned 20-Year 3.0s and 3.5s – Seasoned pools with WAMs ranging from 180-200, an alternative to new issue 15-year MBS with higher premiums.
- 30-Year 4.5s – Current production pools collateralized by jumbo loans.
- FNMA DUS and Freddie K’s – The focus for FNMA DUS has been on 7-year finals while demand for Freddie K’s has been on the 4- to 8-year part of the curve. There has also been demand from financial institutions looking for specific DUS bonds that may qualify for Community Reinvestment Act credit.
Mortgage Rates and Refinance Activity
- Benchmark mortgage rates moved higher for the week ending 9/07.
- 15-year mortgage rates increased 3bps to 3.85%, 31bps above the 12-month average of 3.54%, and 10bps above the YTD average of 3.75%.
- 30-year mortgage rates increased 5bps to 4.46%, 29bps above the 12-month average of 4.17%, and 12bps above the YTD average.
- 15-year mortgage rates have increased 65bps in 2018, while 30-year mortgage rates are up 61bps YTD.
Mortgage Applications: Mortgage applications for the week ending August 31 fell 0.1% on a 0.6% increase in purchase apps and a 1.4% decline in refi apps. On a 4w/4w moving average basis, purchase apps are now down 11.7% from their peak back in May.
Housing Data Remained Weak in July’s Construction Spending Data: Construction spending rose a below-estimate 0.1% in July and there were offsetting revisions to activity in May and June. Total private construction slipped 0.1% as 1.0% drop in non-residential building offset a 0.6% gain in residential activity. The weakness in the non-residential categories was widespread while the strength in residential was concentrated in a 2.1% gain in home improvement spending. Spending on single family homes dropped 0.3% from June and is down in four of the last five months. Multi-family activity was weaker for a second month, down 0.4% from June. In the public sector, overall construction rose 0.7% on a 0.3% gain in residential activity and a 0.7% gain in the non-residential category.
Michael S. Erhardt, CPA
Senior Vice President
Vining Sparks, IBG