September 28, 2020
The Fed has purchased over $1tn of agency MBS securities since the start of QE4 in mid-March and they are on track to purchase $1.4tn to $1.5tn by year-end. This is nearly the same amount as they purchased in aggregate during the former mortgage QE periods combined. 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 and significantly higher prices.
Current Yield Spreads
Yield spreads on production coupon MBS compared to Treasurys with similar duration widened for the second consecutive week. Nominal spreads on 15-year MBS to Treasurys widened 2 bps to 43 bps and 30-year MBS widened 3 bps to 78 bps. Implied volatility remains low and MBS have been trading in a narrow range.
Prepayment risk is the primary concern for MBS investors as prices remain high from Fed action to support borrowers. 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.
To help mitigate prepayment risk MBS buyers have favored lower coupons and pools with characteristics that dampen prepayments (low loan balances, 100% NY, low FICOs, investor loans).
The summary below reflects trading activity from last week. We’ve also seen consistent selling of MBS to monetize unrealized gains with some repositioning into lower coupons and/or other collateral with prepayment friction. Selling TBA-eligible MBS remains attractive due to the significant Fed support of liquidity and pricing.
- UMBS 15-year 1.5s to 2.5s (2.0s the most traded)
- UMBS 20-year 2.0s
- UMBS 30-year 1.5s to 2.5s (1.5s the most traded)
- FNMA Jumbos (FNCK 2.0s to 3.0s)
- GNMA Jumbos (MJM 2.5s & 3.0s)
- 15- and 30-year 1.5s 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 bounced higher last week but remain near their historic lows. According to Bankrate.com, the 30-year fixed-rate mortgage increased 8 bps to 3.09% while the 15-year mortgage rate increased 7 bps to 2.55%. In Freddie Mac’s rate survey, which includes points/fees, the 30-year rate increased 3 bp to 2.90% and the 15-year rate increased 5 bps to 2.40%.
Mortgage applications for the week ending September 18 rose 6.8% on a 3.4% increase in purchase applications and an 8.8% jump in refinance activity. The 8.8% increase in refinance activity is the highest weekly increase in six weeks.
The primary/secondary mortgage spread (average 30-year mortgage rate minus 30-year MBS current coupon) increased last week by 4 bps to 1.69%. The current level is 17 bps over the trailing one-year average of 1.51% and nearly 50 bps over the trailing five-year average of 1.20%. Therefore, mortgage rates could still fall almost 50 bps if we see a reversion in the primary/secondary spread.
Michael S. Erhardt, CPA
Senior Vice President, Investment Strategies
Vining Sparks IBG, LP