We analyse how mortgage-backed securities (MBS) issued by U.S. agencies have modestly improved in May compared with the previous month’s weak performance as the fall-out from the banking crisis continues.
- Spreads resilient against $30 billion FDIC auctions.
- Bank unwinds and Fed moves cap advances.
- Bank CMO paper mostly intermediate duration at auction.
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Heavy supply moves investors
U.S. agency mortgage-backed securities (MBS) limped along in May, with auctions and more macro moves ruling the roost. The FDIC keeps marching forward in its efforts to disperse the $60+ billion in Agency MBS collateral, acquired off the books of failed regional banks SVB and Signature.
After auctioning off 50% of the collateral to date over seven weeks (at 2 and 3 ops per week), $30 billion remains to be sold. Those auctions have been a success as to clearing levels and participation, with buyers scooping up medium to longer durations at initial spreads 20 to 30bps wider to comparative collateral. Non-Agency MBS portfolio has been sold entirely, while CMOs still have about 90% left on the original $22 billion acquired in the regional bank failures of April.
Overall, MBS performance and outlook still hinge on what the Fed will do in the following month’s meeting (June 14th), as nothing is certain as to rates hikes ending or even more QE on the way to offset a possible recession heading into year end.
MBS Index Total Return for May collapsed against falling prices, dropping 99 basis points but outpacing duration neutral Treasury index by +11bps. Subsequently, 10yr yields rose 12 basis points to 3.65%, 2s10s yield curve flattened 19 basis points to -76.2, while volatility measures had 3m10y Vols (normalized) +7bps higher to 121.4 on the heels of debt ceiling uncertainty.
Originator supply increased 0.5% month over month to $2.65 billion per day as lenders as they attempt to squeeze as much from a dwindling pipeline as is feasible. The 30yr primary rate spiked to 6.57% at month-end (FHLMC PMMS), while Bankrate’s daily quote has returned to levels not seen since March at 7.06%.
Current production coupons are now focused along 5.5% (45% of hedging), as the wings have redefined along 5%s and 6%s (40%).
Overseas demand is largely sidelined again as all the commotion regarding bank failures and Fed doings relegated them to the sidelines. G2/FN spreads were largely unchanged as Japanese banks did little overall.
Market perspective – CMOs in for the bid were intermediate
While most of the talk on the initial FDIC bid lists has been focused on the $63 billion U.S. Agency Pass-Throughs, there remained another $35 billion in Agency CMOs. As the BWICs (“Bid Wanted in Competition”) steadily gained momentum and acceptance from the street, it now seems finally possible to start selling CMOs.
As we found in the collateral, the lower coupon bias deemed the bonds maxed out in terms of extension risk concerning 30yr 2.5%s and 30yyr 3%s. Similarly, many of the first wave of CMO Sequentials auctioned off were newly minted (2022 issue) and lower collateral paper. The bulk of last week’s auction contained 2%, 2.5% and 3% net coupon tranches off like 2%, 2.5% and 3% collateral.
A simple rule of thumb when evaluating agency CMOs is how it trades relative to the collateral itself, not tranched (i.e., passed through). FNMA 2%s through 3%s trade approximately 60/ to 80/ on spread.
As you can see in the tables below, these traded +75/ to +105/ on spread. That’s about 20bps wide relative to underlying collateral, yet perfectly in line with how the larger blocks of auctioned FNMA pass throughs have traded as well.
It seems, by default, that the auctioned off SVB/Signature paper has carved out a trading band in that range whether its collateral or tranched CMOs. Makes sense given the buyers’ market setting and interest rate backdrop now befalling these below-par vehicles.
To follow is a sample table of some of the CMO bonds auctioned off last week at pre-market levels widely disseminated by the street.
Summary
Weighted Average life of the list was 6.95 years, Effective duration at currently traded levels 5.51 years. Spreads were generally +90/, yielding 4.68% (much like a 30yr FNMA 3.5% TBA), 60 OAS (greater than a 5.5% TBA), and Zspreads +88/.
All in all, the CMO list was not that long in duration or average life relative to the pass-through collateral, and much in keeping to what banks regularly put to work in the intermediate portion of the yield curve.
Month to date
Spreads have widened steadily this month, growing worse in the final weeks before month-end indexers pared the losses. From mid-month onward, widening gapped out to double digits as Vols increased and buyers ran for cover. The tenor of the market soured with many headwinds yet to finalize, and MBS spreads reflect just that.
The 30yr current coupon (30yr CC) rose 29 basis points (to 5.48%), OAS pared the widening to just one basis point (50.3), ZV (Zero Volatility) pushed out 7 bps to 163.4, and the closely followed correlation to 5&10yr Treasury shaved the gap at +9 basis points at +178.9.
Covid era to present
Results dating back 3+ years from March 13, 2020, show that things have changed more dramatically. Rates are roughly 300 bps higher along 30yr Current Coupon measures, which are reflective of general interest rates. The 30yr CC level is +301bps, meanwhile, OAS spreads are tighter 17bps as levels gapped out right around the crisis. Conversely, ZVs are out 30bps, and vs the 5&10yr treasury blend +15bps reflecting a rocky and turbulent week when the world shut down in 2020.
