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As we wind into the holiday season, conferences are slowing down a bit. Even though we are not attending any industry events in November, we have been very busy with new releases to our core platforms, CompassPoint™ and CompassPPE™. If you would like more information on these updates or to learn more about our service offerings in general, please email firstname.lastname@example.org.
The treasury yield curve remains flat with the 2-10 year spread currently at 27bps, essentially equal to one month ago. For the past month, the 2-10 spread has been range bound between 22 to 38bps with the difference this month being the increase in interest rates.
While interest rates are increasing, the US economy appears to be red hot, in spite of what appears to be the beginnings of a global trade war. GDP growth remains robust and payroll employment growth has continued to accelerate this year. Given a promising economic outlook, the FOMC minutes showed a Fed growing more comfortable with gradual rate hikes.
The market is pricing in a 74% chance that Fed raises rates another 25bps on December 19, 2018. Given recent market activity, the general consensus has shifted from 3 or 4 Fed rate hikes in 2019 to the possibility the Fed may pause in 2019 after December’s rate hike. Equity markets have been very volatile in recent weeks, and risk-off sentiments continued to spread to bond markets, dragging credit spreads wider. Seen as the driver of this recent cheapening of multiple sectors are rising real yields which continued their move higher, the 10 year “real” rate increased 4bps to 1.08%.
Home prices nationally, as measured by the S&P CoreLogic Case-Shiller index, are running up 6.0% year- over-year, as of the latest data in July. Assuming some modest slowing into the end of the year, home prices are on track to end up 5.0% this year. Home prices should be a function of housing supply and demand as it’s likely that existing home sales peaked at the end of last year and have since been moving sideways. This is likely due to affordability, which has been challenged from rising mortgage rates and elevated home prices, while inventory levels have remain extremely low. With mortgage rates heading higher, the challenges with affordability will continue. Based on the NAR’s affordability index, a 50bp increase in mortgage rates would need about a 5.5% offsetting drop in home prices in order to keep affordability unchanged, assuming no change in income.
Rising interest rates and the slowdown in home price appreciation will likely have an effect on agency MBS supply. Industry research is forecasting $228b net agency MBS supply for 2019, a 16% decline in net issuance relative to their 2018 estimates – the refinancing activity percentage is expected to decline. The decline in net issuance is driven by a combination of slowing cash-outs, unwinding of the legacy non-agency RMBS market, more stable origination pipelines in contrast to 2018, and increased retention by the GSEs, who are currently well below their mandated portfolio caps.
– Jason Freydberg
We saw rates gap higher early in October following the employment report as fears of inflation and the possibility of the Fed accelerating its tightening cycle took hold. As of October Class A notification, FNCL stood at 3.99%, up 23 bps versus September while our Conv 30Yr note rate landed at 5.22%, tacking on 20 bps. Trust IOs gained about 15 ticks on average with multiples up about 11 ps. In TBAs, the 3.5/4.0 coupon swap came in about 6 ticks wider while the 4.0/4.5 swap was 7 ticks wider. With widening in coupon swaps, we expect to see some significant deviations from Trust IO ratios in current production note rates as Agencies reprice multiples for November.
– Virgil Caselli
Excess Primary-Secondary Spreads Color
We began September with FN30 MBS yielding 3.62% (FNCL) and borrowers paying 4.87% for a moving average excess primary-secondary (xPS) spread of 7 bps. FNCL finished up 20 bps at 3.82% at the end of the month but hit a high of 3.87% on 9/25 and a low of 3.62 on 9/3 during the course of the month.
During September, rates finished the month up approximately 20 bp with FNCL starting the month at 3.62 and finishing the month at 3.82. FNCL slowly but surely trended upwards over the course month starting the month at the monthly low of 3.62. FNCL drifted up to the monthly high of 3.87 on 9/25 before declining a bit to end the month at 3.82. With rates trending upwards, some originators saw stagnation or a slight up tick in production but most originators remained under capacity. Last month 8 lenders stated that they were under capacity with 6 saying they were significantly under capacity. This month with rates increasing significantly, 5 originators stated they were severely under capacity, 3 significantly under capacity, and 14 slightly under capacity. September saw flat to small decreases in production compared to August. 8 clients saw an increase in production compared to 9 in August. 20 of 28 clients reported that production was either flat, slightly down or significantly down. With reports of flat to down production compared to August, reports of backlog decreased compared to last month with 2 survey receipts stating they had small backlog. With rates increasing this month, reports of excess margin stayed effectively the same as well. This month 8 clients reported having a little extra margin in their rate sheets compared to 8 clients last month.
We ended October 16th with FNCL at 3.97% and our moving average xPS spread at 3 bps. Next month, even if FNCL bucks course and trends downward again we are expecting to see xPS decrease as the recent increase in rates is substantial enough that rates would have to drop significantly to have xPS increase next month.
– Mike Vough
Specified Pool Commentary
The volatility market participants experienced in the month of October has not been seen since 2008. Uncertainty about future rate hikes and the direction of the Federal Reserve threw markets into a tail spin. Investors and Economists alike did not know how to interpret Fed Chairman Powell’s comments from September’s FOMC meeting minutes that were released on October 17th. Powell commented rates are a long way from so-called neutral, a level that’s neither accommodative nor restrictive. The ambiguity in his statement is the reason for the turmoil we have seen during the latter half of the month. Cleveland Federal Reserve President, Loretta Mester, spoke last week about the turmoil: “This is a natural thing that’s going on in the market… Of course it gets your attention, we monitor it, but right now I think of it as a risk to the outlook.” The majority of market participants focused on Chairman Powell’s minutes from the September meeting, but President Mester advises participants to look at communications as a set, “[Powell] does not make the decisions on rates by himself. I think you should listen to the whole group, [referring to the entire policy committee].” Mester is underscoring the importance of the Fed being an apolitical organization and reminding participants the Fed is goal orientated rather than politically oriented as some have suggested given President Trumps comments about Chairman Powell. President Mester sees a gradual path forward for higher rates, per the Fed’s 3 percent target, but will not let outside influences deter them from their mission.
Of note, pay-ups were a mixed bag from September to October. The appetite for FN30 3.5 Coupon completed disappeared as there were little to no pay-ups across the pools. The FN30 4.0 coupon saw little increases across all pools. The 110k pool and 125k pool saw the largest increases as both pools increased 1/32 and 2/32 respectively. Pay-ups for the FN30 4.5 coupon increased by 2/32 across all pools. Pay-ups for the FN30 5.0 coupon saw the greatest spreads. The 175k and 200k pools experienced the greatest pick-up as those pools increased 9/32 and 5/32 respectively. There was relatively little month over month change across the 3 coupons for FN15. However, the FN15 3.5 and FN15 4.0 coupons experienced significant changes across pool structures. The FN15 3.5 coupon experienced the greatest decrease in the coupon stack. The 85k pool decreased by -4/32, while the 125k pool decreased by -3/32. The FN15 4.0 coupon experienced the greatest variance as the 85k pool decreased by -6/32, while the 125k pool decreased by -1/32.
– Brendan McPartland
Bond prices have sold off through September and into October as rates have risen, and during this period we have observed an increase in MSR Rich/Cheap IRRs and a tightening of the Best Efforts to Mandatory spreads while Gross Profit margins remained flat relative to September’s observations. As a result we have seen the FN30 current coupon break 4.0% during the month of October. MSR values have seen an increase in October as aggregators pull back their bid on servicing assets. The average IRR value was 8.49%, a +0.52% increase compared to the September readings, with a peak value of 9.71% and a low value of 6.69%. In October we observed a tightening of the Conventional Best Effort (BE)/Mandatory Spread while Profit Margins remained flat relative to last month. The peak BE/Mandatory Spread value was 44 bps and the trough was 31 bps, with an average value of 36 bps, which is a 2 bps decrease from our September readings. Profit Margins displayed an average reading of 203 bps (no change relative to last month) with a peak of 220 bps and a trough of 184 bps.
The MSR Rich/Cheap gives the internal rate of return for retaining servicing and provides a general measure of how aggressive aggregators are in their servicing bid. If a client is considering retaining servicing, or is deciding between retaining or selling servicing-released on any given day, this number can serve as a guide. Compass uses best execution across aggregators each day for note rates bracketing the FN30NR. The Mandatory/BE spread tracks the difference of a representative seller’s basis point pick-up using mandatory delivery instead of best efforts. Compass uses several investors, for best efforts and mandatory, and compares the best execution of each of the two delivery methods for note rates flanking the FN30NR. The Conventional 30-year average gross profit margin tracks the originator’s gross profit margin, i.e. the difference between what the originator pays for the loan (what is posted on a rate sheet) and what the originator could sell the loan for into the secondary market.
– Sean Welsh
Production in the 30-day period ending October 18, 2018, increased while rates traded in a wider range (24 bps range in this period versus 15 bps in the prior period), with the average yield increasing month over month by 22 bps. Average volume for the last 30 days was 90% of our base volume (vs. 86% in the prior period) ranging from a low of 61% to a high of 128%. The average yield on the FN30 RNY in this period was 4.414% (vs. 4.195% in the prior period) ranging from a low of 4.281% to a high of 4.555%.