September 14, 2020
The Fed has purchased over $1tn of agency MBS since resuming QE in mid-March. For context, total net issuance from 2017 through 2019 was $893bn. Since the beginning of QE4, the Fed’s ownership of agency MBS has increased from 21% in late March to approximately 29%. The Fed’s sponsorship of the sector has led to reduced volatility, higher prices, and tighter spreads.
Current Yield Spreads
Following a recent pattern, yield spreads on production-coupon MBS compared to Treasurys tightened last week. Spreads on 15-year MBS to Treasurys tightened 4 bps to 32 bps and 30-year MBS narrowed 1 bp to 66 bps. The Fed’s MBS purchases have helped drive spreads tighter 26 to 28 bps this year.
Prepayment risk is perhaps the most acute concern for MBS investors. Fannie Mae recently reported that using a 2.93% driving 30-year mortgage rate, that 64% of all mortgages are at least 50 bps in the money, and this rises to 77% when looking at conventional mortgages only. Even more troubling, these figures are with the primary/secondary mortgage spread being approximately 50 bps over the 5-year trailing average. Lenders have the spread elevated to manage risk and capacity.
To help mitigate prepayment risk MBS buyers have focused on lower-coupons and pools with characteristics that make prepayments less likely (low loan balances, 100% NY, low FICOs, investor loans).
The summary below reflects trading activity from last week. We’ve also seen a noticeable uptick in investors selling MBS to harvest embedded gains and some repositioning into lower coupons. Selling TBA-eligible MBS remains attractive due to the significant Fed support of liquidity and pricing.
- UMBS 15-year 1.5s to 3.0s (2.0s the most traded)
- UMBS 20-year 1.5s & 2.0s (2.0s the most traded)
- UMBS 30-year 1.5s to 3.0s (1.5s the most traded)
- FNMA Jumbos (FNCK 2.0s & 3.0s)
- GNMA Jumbos (MJM 2.5s)
- 15- and 30-Year 2.0’s to 3.0’s LLB Pools ($85k -$200k max loan size)
- Custom CRA Pools
Given the 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 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
Mortgage rates were mixed last week and continue to bounce around historic lows, according to Bankrate.com. The 30-year fixed-rate mortgage decreased 1 bp to 3.05% while the 15-year mortgage rate pushed higher by 2 bps to 2.55%. In Fannie Mae’s primary mortgage market survey, 30-year rates declined to 2.86%, another all-time low. This is the ninth record low since March.
Mortgage applications for the week ending September 4 rose 2.9% on a 2.6% gain in purchase apps and a 3.0% increase in refis. As an indicator for future home sales, purchase apps have slowed their pace of gain over the past three weeks but continue to point to incremental improvement.
The primary/secondary mortgage spread held steady last week at 1.69%. The level remains 20 bps over the trailing one-year average of 1.49% and 50 bps over the trailing five-year average of 1.19%. Mortgage rates have additional room to decline further if we see a reversion in the primary/secondary spread.
Prepayment speeds were released last week for August activity. Conventional coupons of approximately 3.0 and lower saw speeds increase by more than a token amount and, while higher coupons technically declined, they really remained largely the same. GNMA speeds followed the same trend except higher coupons (4.0+ coupons) saw more meaningful declines. Our complete mortgage prepayment commentary can be found here.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP