HMBS spreads swung violently wider after the Fed meeting in mid-June. Dollar prices gapped out just above two points overnight as the market came to the conclusion the Fed would begin tapering bond purchases sooner than expected. Liquidity got crushed across all mortgage products and spreads continued wider after the June employment report came in stronger than expected.
Spreads on the fixed-rate Standard and Saver jumped 35 basis points with Libor Standard and Saver jumping 40 to 45 basis points. Dealers and originators were massively caught off guard with the swift re-pricing of the sector, but spreads have stabilized at wider levels as rates have retraced most, if not all, of the directional move. I expect some tightening back to previous levels, but it will be slow and methodic.
Additionally, there’s been some dealer turnover as new dealers have emerged while others back out of the space. This recent turnover aggravated the liquidity crunch and dealt a blow to large buy-side investors who tested market liquidity and came up unimpressed. (Dealers in this sector continue to shoot themselves in the foot!)
In terms of flows, we saw clear differentiation in seasoned, fixed-rate paper trades in relation to spread, but those demarcation lines are currently absent from the market. Two- and three-year average life paper trades at the same spread as recently issued five-year fixed Standard paper, which has created great relative value trading opportunities.
Originators are originating almost exclusively Libor Standard product now and hedging pipelines with August settle deliveries. We’re seeing mostly 100 percent drawn line-of-credit product hit the Street, with dribs and drabs of Saver. Issuance volumes will continue to plunge from the local highs we saw in April (roughly 1 billion); Issuance dropped to 850 million in May and 700 million in June. July will be well under the 700 million mark and you can expect the trend to continue to lower through the end of September.
What the HECM program will look like come October 1 is anyone’s guess, but many market participants are preparing for a 100 percent Saver marketplace. There are also discussions of creating a new product PLF table and eliminating the Standard and Saver products entirely with a “brightline” utilization line, which will dictate if the 2 percent MIP will be charged or not.
In any event, House Republicans have introduced a bill to eliminate the HECM program and there’s still the ongoing effort to get the bill passed in the Senate to allow for the FHA to introduce Financial Assessment. So what to expect here? Continued stress coming from D.C. as FHA reform, GSE reform and the HECM program remain in focus. You can also anticipate a lack of conviction in spreads as we’ll see near tightening off the recent lows, but summertime malaise will keep that tightening capped. Expect directionless flows and the origination landscape to continue to turn over as platforms trade into new hands, recent market participants drift away into other initiatives, and recently completed mergers and consolidation/integration take place. Oh and don’t forget, the SEC/GNMA true sale accounting problem will be 2 years old in August!