Agency MBS Update for December

Monthly Commentary

January 06, 2020

Agency MBS relative valuations continued its outperformance from November, riding the wave of a risk-on rally and higher interest rates. In December, there was a trifecta of good news for risk assets – a dovish Fed, progress on the trade war between U.S. and China, and a significant step forward on Brexit. The ensuing rally brought the S&P 500 to another round of all-time highs, ending the month 2.86% higher. Interest rates also sold off with the 10yr UST, ending the month 14bps higher at 1.92%. Agency MBS benefited from both the interest rate selloff and the risk-on sentiment to return 34bps of excess performance in December, closing the year with excess returns of 61bps. Total return remained strong at 6.3% year to date.

There was a divergence in performance between UMBS and GNMA this month as peak speeds were meaningfully slower in UMBS multi pools while GNMA multi pools did not slow down as much. With December’s lower day count (three fewer than November) and a higher running mortgage rate, peak speeds in UMBS 30yr multi pools across 3.5s – 4.5s fell 10% to 25% over the month. On the other hand, GNMA multi pools failed to slow down with G2 3.5s actually paying slightly faster than the previous month at 74.7 CPR and G2 4.0s and 4.5s only dropping ~3% over the month. As a result, conventional 30yrs posted 44bps of excess return while GNMA 30yrs posted 16bps of excess return. Conventional coupon stack performance was similar with 2.5s to 4.5s posting similar gains. FN 2.5s managed to inch out the best excess return at 46bps with low supply as rates backed up. In G2s, G2 3.0s posted the best performance with continuous demand from overseas investors and banks. High coupon G2s were the worst performers with G2 5.0s posting 12bps of negative excess returns.

Average Peak CPR in 3.5 - 4.5 Multi Pools

Source: eMBS, TCW

The Agency MBS market was subjected to large structural changes in 2019. Most prominent was the Single Security Initiative with the launch of UMBS in June. Soon after implementation, the prepayment landscape changed rapidly as a result of such changes along with an interest rate rally and technological advancements. All in all, the year presented multiple headwinds to the Agency MBS market that lead to a significant deterioration of the TBA Deliverable. In GNMA space, VA loans continued to pay fast with G2 multi pools still suffering from fast peak speeds. UMBS did not fare any better with worsening convexity profiles from wider Weighted Average Coupon (WAC) spreads along with steeper and quicker prepayment ramps. Fintech advancements further damaged UMBS as the hurdles to get a mortgage became easier. For example, Property Inspection Waivers (PIWs) serve to reduce costs, streamline the origination process, and avoid appraisal delays but ultimately cause faster prepayment speeds for the investors. Loans with PIWs have been growing and we expect the trend to continue in 2020. Despite these headwinds, a strong risk appetite brought Agency MBS excess returns into positive territory, ending the year at +61bps. However, it still lags IG corporates which returned excess returns of +676bps. All eyes will be on net supply and speeds to see if mortgages can generate stronger performance next year.

 

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This material is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. TCW, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. The information contained herein may include preliminary information and/or "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. TCW assumes no duty to update any forward-looking statements or opinions in this document. Any opinions expressed herein are current only as of the time made and are subject to change without notice. Past performance is no guarantee of future results. © 2019 TCW