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Near par, 15-year MBS lags 30-year MBS

| January 31, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Spreads on 30-year MBS have tightened to 15-year MBS since mid-January by almost 13 bp, which is the lowest level since early September and close to the lowest levels of the last year. Investors looking for shorter duration MBS suddenly have something to consider as an alternative to 30-year near-par MBS: investing in 15-year near-par MBS.

The spread between par 30- and 15-year MBS has collapsed

On January 17, the spread between the 30- and 15-year mortgage current coupons stood at 43 bp and had traded close to that level since the beginning of October. But since then the spread has plummeted to 29 bp (Exhibit 1). The current level comes close to the lows of 2019, which came in early September when markets were roiled with concerns about an inability to reach a trade agreement with China.

Exhibit 1: The spread of 30- to 15-year MBS has tightened sharply lately

The 30 yr/15 yr basis is the spread between the 30 yr and 15 yr mortgage current coupons. Source: Fannie Mae, Freddie Mac, eMBS, Amherst Pierpont Securities

The price of 15-year 2.0%s has significantly underperformed 30-year 2.5%s since mid-January. Most 15-year MBS tend to have durations similar to the 30-year MBS with a coupon 50 bp higher, so these prices generally move together. But there has been very little supply of 15-year 2.0% MBS, and only $15.5 billion of pools eligible for TBA delivery.  As interest rates have dropped, most market participants are not yet treating the 15-year 2.0% as the production 15-year coupon and seem reluctant to price 15-year 1.5%s.  This is pressuring the FNCI 2.0% contract to remain slightly below par and is preventing it from repricing fairly with the FNCL 2.5% TBA.  But if interest rates remain at or below current levels for a while, this is likely to correct and the FNCI 2.0% contract should re-price higher.

The yield curve has flattened as well, from 20.3 bp on January 17 to 17.8 bp on January 30. In a flatter curve, 15-year MBS should underperform partly because of their higher exposure to 5-year and shorter key rate duration and arguably because a flatter curve can induce borrowers to refinance into 30-year mortgages from 15-year mortgages. Nevertheless, the 30-year to 15-year mortgage basis appears tighter than typical for the current shape of the yield curve (Exhibit 2).

Exhibit 2: The curve suggests the basis between 30- and 15-year should be wider

Data since 1/1/2019. Source: Fannie Mae, Freddie Mac, eMBS, Amherst Pierpont Securities

15-year 2.0%s and 2.5%s look cheapest

The FNCI 2.0% appears to be the most attractive part of the stack (Exhibit 3). They now trade 20/32s behind FNCL 2.5% with the 30-year paper just above par. When FNCL 3.0%s traded near bar, the comparable 15-year coupon traded at roughly the same price as the FNCL 3.0%s. And when FNCL 3.5%s traded near par, the comparable 15-year coupon again traded at rough the same price at the 30-year paper. The current lagging price on FNCI 2.0%s is striking.

Exhibit 3: FNCI 2.0%s and 2.5%s look cheapest

The price spread of each coupon is calculated relative to the 50 basis point higher FNCL TBA and plotted against the FNCL TBA’s price. A wider price spread indicates the FNCI is cheaper relative to the FNCL contract. Data since 1/1/2019. Source: Fannie Mae, Freddie Mac, eMBS, Amherst Pierpont Securities.

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