Mortgage Market Weekly Trading Floor and Strategy Notes

Market Overview and Mortgage Strategies

  • Market Sentiment and Positioning:

    • Mortgages are currently viewed as being on the tighter end of the spectrum from an Option-Adjusted Spread (OAS) and zero-volatility (ZV) spread perspective.
    • The market experienced a significant curve move on Thursday, leading to an underperformance in mortgages, with an expectation that there is more movement to follow.
    • The current level of curve flatness, specifically the 2×102 \times 10 (two-year versus ten-year) spread, is at historical lows. In previous instances where the curve was this flat, mortgages were meaningfully wider.
    • Despite being tight, mortgages still appear favorable when compared to other risk assets.

  • Sustainability of Tightness:

    • Tightness is being maintained by three primary factors:
      1. Light Supply: The current supply of mortgages in the market is quite limited.
      2. Systematic Buying: Driven by volatility (vol) or anticipation of specific flows, systematic buyers have been active.
      3. Yield Demand: Current yield levels have reached a point where they are attracting specific yield buyers.
    • Strategic Recommendation: For those in basis form or acting as hedgers, this is considered a peak point where profit-taking is recommended.

  • Flows and Participant Activity:

    • Systematic Buyers: Consistent buying activity throughout the week.
    • Hedge Funds: Mixed activity, but leaning towards being net buyers.
    • Money Managers: Primarily acting as sellers.
    • Yield-Driven Investors: Acting inconsistently, moving in both directions.
    • Real Money (Servicers and REITs): Activity has been notably quiet or absent from major transactions.

Desk Activity and Specific Coupon Performance

  • Transaction Highlights:

    • The desk saw a diversified interest across various participants last week.
    • Bank Activity: Banking institutions were active in the lower coupons, specifically adding in 2%2\% and 3%3\% coupons. Conversely, banks were sellers in June 2024 5.5%5.5\% coupons.
    • Money Managers: Adding positions in specific, targeted spots.
    • Hedge Funds: Quiet overall but skewed toward selling loan balance positions in higher coupons.

  • Specific Deals and Inventory (Axes):

    • BK Transactions: Sold a significant piece of FICO 3%3\%s to a bank and a large amount of 2%2\%s to a money manager via ABS (Asset-Backed Securities).
    • Sixes and Six-and-a-Halves: Currently a major axe for the desk. Approximately $50,000,000$ of bank service 6%6\%s were moved into a real money account. There is still a significant inventory of 6%6\%s and 6.5%6.5\%s to be sold.
    • Ginnie Mae (GNMA): The desk is looking to sell Ginnie Mae II 5.5%5.5\%s.
    • The importance of staying in front of accounts was emphasized, particularly as summer vacations approach, to maintain connectivity and follow-up on recent sales.

CMO (Collateralized Mortgage Obligations) and Structural Trends

  • CMO Market Conditions:

    • The past week and month have been slow for the CMO sector, with new issuance essentially concluding.
    • Current demand is heavily concentrated in floaters (both Ginnie Mae and conventional) due to the flattening curve and more attractive coupons resulting from the sell-off.

  • Structuring Strategies for Fixed-Rate Bonds:

    • Moving fixed-rate bonds remains difficult. To combat this, some deals are being structured with Principal Only (PO) components.
    • Demand in the fixed-rate space has been cannibalized by GMCs (Guaranteed Mortgage Certificates) in both ARM and fixed-rate forms.
    • GMCs have tightened by 5 to 75 \text{ to } 7 basis points recently. The desk is offering similar average-life profile fixed-rate bonds at levels more than 1010 basis points wider for accounts that do not require stated finals.

  • Collateral and Resource Management:

    • The desk is looking to move principal risk through seasoned pools including Ginnie Mae 5.5%5.5\%s, Ginnie Mae 6%6\%s (not currently on sheets), and conventional 6%6\%s.
    • Current dollar prices have decreased significantly, making these attractive to bank and money manager accounts seeking low-par, high-yield opportunities.

Derivatives and Inverse IO (Interest Only) Performance

  • Derivative Market Resilience:

    • Despite being a short week, the derivatives desk was busy with robust volume and customer buying.
    • Money managers were selling conventional 6%6\%s and 6.5%6.5\%s and loan balance 6%6\%s and 6.5%6.5\%s.

  • Pricing and Spreads in Derivatives:

    • Spreads are compressing and the market remains healthy.
    • Seasoned conventional 6.5%6.5\% Inverse IOs are clearing in the high 400400s.
    • Loan balance conventional 6.5%6.5\% Inverse IOs have tightened to the low 200200s.
    • Low-coupon IOs (specifically Ginnie Mae) are trading at the tightest levels seen, with some fast money participants taking profits at up- %100\%100 levels.

  • Prepayment and Risk Axes:

    • There is a perceived significant prepayment upside in the current elevated rate environment, which supports derivatives prices.
    • Specific Major Aks/Risk to Reduce: Looking to exit Ginnie Mae loan balance risk (priced to perfection). Specifically targeting loan balance 6%6\%s and 6.5%6.5\%s, including bond $25.01 \text{ } 46 SC$.

Hybrid ARMs (Adjustable Rate Mortgages) and GMCs

  • Transaction Volume and Spreads:

    • Hybrid ARMs saw approximately $700,000,000$ to $800,000,000$ in BWIC (Bid Wanted in Competition) volume, mostly from origination.
    • OAS widened slightly during the sell-off:
      • 7/17/1 ARMs: Moved from 29→31 OAS29 \rightarrow 31 \text{ OAS}.
      • 5/15/1 ARMs: Moved from 38→39 OAS38 \rightarrow 39 \text{ OAS}.
    • Expectation for bank buying increases as dollar prices hit high $99\$99 (low par).

  • Sponsorship Gaps:

    • Ginnie Mae 4.5%4.5\% and 5% 5/15\% \text{ } 5/1 sectors have lost buyers recently and are now trading at wider OAS than conventionals, which is historically unusual.
    • Major Axe: A 4-year GMC (FNR 2652 MB) with a 2030 final. This bond fills a "middle space" in the curve that is currently empty of supply.

CMBS (Commercial Mortgage-Backed Securities) Analysis

  • Market Lag and Yield Opportunities:

    • CMBS has lagged behind other spread products and risk assets during the recent tightening phase.
    • The move in the curve (specifically the 2×52 \times 5 year part) is driving front-end demand from banks. The 22-year treasury context has moved significantly, with the curve flattening by 5050 basis points in a week.

  • Asset Performance and Inventory:

    • The desk likes 10/910/9s on an asset swap basis as they are well-anchored and supply is difficult to source.
    • New Acquisition: $141,000,000$ of a 7/6.57/6.5 partial IO. These have lagged the broader sector move and offer wider spreads, particularly for those willing to take premium risk (high 3030s range).
    • Major Assets for the Week:
      1. $141,000,000$ of 7/6.57/6.5 partial IOs.
      2. $58,000,000$ of 10/9.510/9.5 credit facility.

Discussion and Critical Follow-ups

  • Federal Reserve Outlook: The recent repricing in the front end is significant. While BNP Paribas predicted the hawkishness, it still surprised the broader market.
  • Information Request: Leadership is seeking feedback on what accounts are thinking regarding the front-end repricing and Fed hawkishness to improve positioning and connectivity.
  • Unresolved Query: Annie requested intelligence on why conventional 6%6\% and 6.5%6.5\% Inverse IOs are tightening so aggressively, seeking to understand if it is a specific view on conventionals or a combination of factors.