April Agency MBS Update

Monthly Commentary

May 07, 2019

It was a quiet month for Agency MBS, closing flat relative to U.S. Treasuries, despite upbeat economic prospects. In March, we saw an increasingly data dependent Federal Reserve pivot to a more dovish stance as it signaled that a rate hike is unlikely in 2019. This month, we saw global risk assets propel higher in response to multiple factors: the accommodative Fed, a strong start to corporate earnings, promising economic data from China, and a healthy U.S. GDP print. The S&P 500 rose above its record highs, interest rates increased in tune with the risk-on move, and interest rate volatility was suppressed in the absence of major macro events. The combination of these factors was a positive for Agency MBS valuations up until the middle of the month when robust supply proved to be too much of a headwind. As total gross issuance rose over 16% month-to-month to $95.6bln, Agency MBS performance started to decline. Ultimately, the Bloomberg Barclays MBS Index posted a small negative return of 1 basis point (bps) versus U.S. Treasuries in April, keeping yearto- date relative performance to a positive 27 bps. Total returns remained strong at 2.11% year to date.

The rise in interest rates and low volatility environment reversed the coupon stack performance from last month as higher coupons outperformed and lower coupons underperformed U.S. Treasuries. Fannie Mae 30yr (FNCL) 4.5s and Ginnie Mae (G2SF) 5.0s were the best performers, finishing up 30 bps and 68 bps, respectively, while both FNCL 3.0s and G2SF 3.0s were down more than 20bps. The drop in mortgage rates continues to create prepayment risk concerns as over 30% of the agency MBS universe remains economically re-financeable, up from about 7% earlier this year. The prepayment report this month provided temporary relief but the consensus forecasts speeds increasing in upcoming months. As prepayment concerns linger, specified pools had another solid month despite a wave of selling driven by profit taking. Dealers and end accounts digested the supply well, allowing pay-ups to remain fairly stable over the month. In Ginnie Mae MBS, we saw a focus in post-ramp, high-coupon G2SF multi pools as post-ramp speeds came in faster than expected. Analyzing loan level data shows that the speed increase can be attributed to the increase in prepays on loans serviced by Freedom as they were allowed back into the Ginnie Mae II multi-issuer program. Back in June 2018, Freedom along with Sun West and New Day were banned from pooling their VA loans into the main securities program due to their churning of military veteran borrowers. As the Ginnie Mae II multis are more diversified and can be delivered into G2SF TBAs, they tend to trade better than non-deliverable Ginnie Mae II custom pools that often trade at a discount to G2SF TBAs. To get the best prices for their loans, these servicers had an incentive to behave to get back into the Ginnie Mae II multi-issuer program. For Freedom, Ginnie Mae’s restrictions proved to be somewhat effective in curbing churning practices and it was allowed back into the multi-issuer program starting last month. With the restriction now lifted, however, Freedom’s speeds have spiked back up to levels significantly above the cohort and even above where they were paying before the restriction. Weighed by loan balance, Freedom speeds now average 10 CPR faster than where they were before the restriction. A further examination of loan level data suggests that some smaller servicers, including Sun West, are exhibiting a similar pattern with speeds picking up again after the initial ramp. It is yet unclear if Ginnie Mae will impose further restrictions on these servicers and investors will have to be more selective while finding value in the high coupon Ginnie Mae multis.

Next month marks the beginning of UMBS exchanges with forward UMBS TBA contracts already trading in the market. Starting May 7, Freddie Mac will start accepting Gold PC pools in exchange of UMBS and UMBS pools will be open for delivery for June settlement. By June, we will have issuance of UMBS pools from originators and indices are expected to reflect UMBS and Supers in their holdings. As a brief overview, UMBS is the creation of a single TBA contract and a single security securitization platform for Fannie Mae and Freddie Mac. The stated rationale for UMBS is to increase liquidity but the clearer goal seems to be to pave the way for GSE reform. While GSE reform remains far off, the rolling out of UMBS has created some rather unintended market impacts. Some of these include fluctuations in the swap levels between Freddie Mac and Fannie Mae TBAs, higher GWACs on recently issued specified pools, and the rapid increase in specified pool pay-ups with a worsening TBA float. With full implementation right around the corner, market participants must be wary and be ready to face any additional unforeseen consequences as we navigate through a bumpy road towards UMBS. On the GSE front, Mark Calabria was sworn in as the next director of the Federal Housing Finance Agency and will be a key figure in the Trump administration’s effort to reform the two GSEs. Although GSE reform is not imminent and will be a long drawn out process, Calabria’s appointment may provide some momentum for housing finance reform in areas that only require administrative changes. Legislative changes seem more likely after the 2020 elections.

 

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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