Intermediate and long Treasury yields backed up last week to levels last seen in early November. The 10-year Treasury yield ended the week at just below 1.92%, almost 10 basis points higher on the week. While shorter-maturity bills and notes also sold off, their yields only rose by between 2 and 4 basis points, leaving the yield curve significantly steeper; the 2-10 year spread closed at +29, its widest level since June 21st of this year. The long-end selloff was driven both by a rise in real yields (i.e., rates without an inflation component, proxied by the 10-year TIPS yield) and a pickup in long-term expectations for inflation, with the 10-year TIPS break-even rate increasing by 6 basis points to 178 bps, its highest level since late July.
*The MBS Weekly Market Profile Report corresponds to the commentary below.*
The selloff helped continue the tightening trend for MBS. The Fannie Mae 30-year current coupon spread over Treasuries narrowed by about 3 basis points, and is tighter by about 13 bps from its level in mid-November. Coupon swaps were, surprisingly, mixed last week. 30-year Fannie swaps widened modestly, as you’d expect in the face of a selloff, while Ginnie swaps were mixed, with the 3/2.5 swap expanding by 7/32s while the 3.5/3 swap narrowed by five ticks. Dollar rolls have contracted after December’s settlements were completed, as the Jan/Feb rolls don’t embody the same fear of year-end funding pressures as did the Dec/Jan rolls. The only roll trading notably special is the GNII 3.0 roll, while the GNII 3.5 roll was, at -1 3/8, solidly in negative territory.
One other interesting note is that, despite the uptick in yields, trading in conventional 2.5s remains fairly robust. The accompanying chart shows a 3-day moving average of 30-year UMBS 2.5s as a percentage of total 30-year UMBS trading, and indicates that 2.5s have recently comprised 10% or more of overall conventional MBS trades (both TBAs and specified pools). 
Click to enlarge Along with continued Fed purchases of the coupon (for the first time since 2013), it suggests that UMBS 2.5s are becoming increasing accepted as a trading and investment vehicle, and can be traded and shorted without major fears of a short squeeze. (This is not yet the case in Ginnies, where GNII 2.5s volume share is smaller and significantly more volatile.)
The FHFA recently put out a request for input for a proposal to change UMBS MBS issuance and trading practices. The proposal, available at FHFA.gov, is primarily intended to continue to “align” the price and prepayment performance of UMBS pools issued by Fannie Mae and Freddie Mac by creating larger and ostensibly more “fungible” pools. The proposal has three parts:
- Issuers would be required or incentivized to deliver their conventional issuance into multi-issuer pools, instead of single-issuer pools. This would be accomplished either through more sales being directed to the GSE’s cash windows or (for originators or correspondents that securitize their loans directly) pooling fewer loans into single-issuer pools and more into multi-issuer pools. The document indicates that the FHFA is targeting 70-80% of production to be pooled in multi-issuer pools.
- Specified pools (which are predominately single-issuer pools, with the exception of Fannie and Freddie’s cash pools) could continue to be created and traded “for prescribed categories.”
- Originators whose production displays “anomalies in prepayment speeds” would be directed to issue some or all of their production into single-issuer pools that would not be deliverable into TBAs and would almost certainly trade at major price discounts to TBAs.
While the proposal is fairly complicated, our views can be summarized as follows:
- Changes to pooling practices to reach the proposed target are unnecessary. For example, data and analysis from Refinitiv indicate that 75% of production in 2019 (through October) has been pooled into multi-issuer pools, up from 68-69% for 2016-2018.
- While creating larger pools will reduce the risk that investors will receive pools that exhibit unusual prepayment speeds, it probably wouldn’t impact the relative speeds of Fannie- and Freddie-issued pools, especially since “first-level” pools can’t commingle loans from the two GSEs.
- A regulated specified pool market would be less dynamic and adaptable to changes in elements such as the conforming balance limits; moreover, it’s unclear how it would be regulated, since issuance and trading are supervised by a combination of the FHFA, FINRA and SIFMA.
- Forcing issuers with relatively fast prepayments speeds to pool into non-deliverable pools would represent an extremely severe penalty; we also expect that it would disproportionately impact small- and medium-size originators.
This is our last commentary for the year. Happy Holidays to all our clients and readers.
About the Author: Bill Berliner
As Director of Analytics, Bill Berliner is tasked with developing new products and services, enhancing existing solutions, and helping to expand MCT’s footprint as the preeminent industry-leader in secondary marketing capabilities for lenders.
Mr. Berliner boasts more than 30 years of experience in a variety of areas within secondary marketing. He is a seasoned financial professional with extensive knowledge working with fixed income trading and structuring, research and analysis, risk management, and esoteric asset valuation.
Mr. Berliner has also written extensively on mortgages, MBS, and the capital markets. He is the co-author, with Frank Fabozzi and Anand Bhattacharya, of Mortgage-Backed Securities: Products, Structuring, and Analytical Techniques, which was named one of the top ten finance texts in 2007 by RiskBooks. He wrote and edited chapters for The Handbook of Mortgage-Backed Securities, The Handbook of Fixed-Income Securities, Securities Finance, and The Encyclopedia of Financial Models. In addition, Mr. Berliner co-authored papers published in The Journal of Structured Finance and American Securitization. He also wrote the monthly “In My View” column for Asset Securitization Report from 2008-2012.
