HMBS: Spreads Consolidate, Remain Resilient

Written by Darren Stumberger, as originally published in The Reverse Review.

After a dramatic tightening to start off the year and amid a volatile rate environment, spreads consolidated during the sharp sell-off following mid-March’s Federal Reserve meeting. As we approach publication, current offer side levels for newly issued premium fixed-rate HMBS are 85 to interpolated swaps for corporate settle and 65 discount margin for newly issued premium floating-rate HMBS.

Worthy of note, premium floating-rate HMBS have been better bid than par dollar price floaters, and it will be interesting to see if this trend continues. Fixed rates still compare well (10-40 basis points cheaper) to competing asset classes within the agency commercial mortgage-backed securities (CMBS) sector. They are also beginning to look fair to agency Collateralized Mortgage Obligations (CMOs).

On the floating-rate side, 10.5 percent cap par priced bonds are in the low to mid-60s discount margin, which remain 30-35 basis points cheaper than 7 percent cap Ginnie Mae agency CMO floaters. Spreads should remain resilient and tighten marginally in rate backup scenarios, but don’t expect a meaningful tightening from here (where every new issue auction tightens the market 5-7 basis points). As we enter corporate earnings season, many of the negative underpinnings of the macro environment remain (Europe’s sovereign debt crisis, U.S. unemployment, gas prices, Middle East tensions) and

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should keep rates range-bound and the discussion on QE3 brewing. Economic fundamentals have been generally positive and risky assets have been tightening throughout the winter and early spring, but a sustained backup in rates is not yet warranted in the U.S.

On the secondary side, market activity remains vibrant and continues to see several hundred million dollars of flow per week. Liquidity has remained strong with no observable spread concession for the higher premium, four-year average life paper. Two- to three-year average life paper remains very well bid and trades meaningfully inside of new issue given the spread pick versus competing assets, the roll down the curve and attractive cash flow profile. The Interest Only (IO) market has also tightened recently with dollar prices up anywhere from a quarter to a half a point. Demand still outweighs supply for this sector and we’ll continue to see contraction in yields.

In March, HMBS issuance volume topped $880 million (a 23 percent increase month over month), split 58 percent fixed rate and 42 percent floating rate. Wells Fargo led the top five issuers with 24 percent of the market share (mostly subsequent participations); RMS finished second with more than $200 million of new issuance and a 22 percent market share. Urban and MetLife finished third and fourth with 18 percent and 17 percent respectively, and Generation finished fifth with 8 percent of the market share. In March there was $455 million in securitized deal issuance brought to market by three Ginnie Mae sponsors, bringing year-to-date issuance to $830 million.

2011 fixed-rate prepayments dropped more than 30 percent in March with floating-rate dropping 14 percent. As a whole, the 2011 vintage of HMBS is running roughly 50 percent of the baseline prepayment curve. 2010 prepayments also dropped marginally and are running closer to 40 percent of the curve. The reduced prepayment risk of HMBS relative to conventional MBS and zero percent risk weighting under Basel III (a regulatory standard expected to be implemented globally) will continue to be attractive features to bank buyers and money managers.

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