HMBS: HMBS Spreads Tighten as Volume Dips

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

HMBS spreads have consolidated after a furious tightening in the beginning of the year. Fixed-rate HMBS is trading roughly 60 to swaps (about $111 dollar price) for corporate settle, which is just shy of a 3 percent yield in the eyes of investors. Floating-rate HMBS has touched wider off the 2014 tights and is trading in the mid-70s discount margin and high $107/low $108 dollar price.

Through February there have been more than $750 million in HREMICs brought to market, with Bank of America Merrill Lynch selling $330 million of these structured securities, Stifel Nicolaus more than $300 million and RBS just over $118 million. The current $750 million issuance total is roughly two-thirds of what came to market during the same period of 2013. Issuance of HREMICs in the first two months of 2013 was in excess of $1.1 billion and can surely be attributed to declining volumes as dealers need longer to aggregate deal-size critical mass (which is typically $150 million or more).

We expect origination volume totals to continue to drop into the spring and summer of 2014 as January HMBS issuance came in 15 percent

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lower than the three-month rolling average. We should see another big drop in February on the order of 25 to 30 percent month over month. As of the last week of February, issuance was just over $400 million for the month. Secondary flows have been strong with a lot of 2011 and 2012 fixed-rate paper trading in the 50s and 60s to swaps, and 2009 and 2010 paper trading 5 to 10 basis points tighter for corporate settle.

IO demand has picked up after several months of softness with yields retracing several hundred basis points in Q1. As we prepare for the NRMLA meeting in New York City, the new fixed-rate products currently being originated in the marketplace have dominated discussions among dealers and investors. Closed-end and open-end fixed-rate loans are being originated under all the standard payment plans (i.e., lump sum, tenure, term and modified tenure, and modified term). While the closed-end product doesn’t raise new risk to GNMA issuers, it does present a much larger exposure that needs to be spread and rate hedged. Issuers as a function of the fixed HMBS program always have rate and spread exposure to subsequent securitizations of MIP

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and the servicing strip, but the exposures now are much greater because they include the unused principal limit of the loan. The open-ended loan raises the additional risk of allowing the consumer to partially prepay the loan and allowing a re-draw at the original interest rate.

In any event, it seems these new permutations of the fixed-rate HECM are here to stay and GNMA issuers will have their hands full hedging the exposure through the rates market. At a quick glance, it took only a 1.5 to 1.75 percent rise in rates for a 10-point premium to evaporate to zero. With this, I wish the issuer community good luck!

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