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The impact of Fed QE4 MBS purchases on TBA

| May 15, 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.

The Fed has bought an enormous amount of agency MBS as part of its strategy to calm financial markets during the COVID-19 pandemic.  The $642 billion in MBS purchased through May 14 marks the fastest pace of any round of QE. The central bank has steadily slowed its purchases through much of April and May, and the majority of its UMBS 30-year buying has settled. Sizable duration and negative convexity has left the market with the Fed concentrating its buying in 30-year 2.5%s and 3.0%s. The Fed has taken out nearly 55% of the float in 2.5%s, improving the chances of a special dollar roll. And in 30-year 3.0%s, the Fed has taken delivery of pools with worse convexity than the remaining float, improving the quality of TBA.

The composition of MBS bought so far in QE4

The Fed bought 30-year UMBS coupons from 2.5%s to 4.0%s but was most heavily concentrated in 2.5%s and 3.0%s (Exhibit 1).  This reflects a desire to prevent the coupon stack from becoming too distorted, but an emphasis on lower coupons also helps support originators and hopefully lowers mortgage rates available to borrowers. These coupons have the longest durations on the stack, other than the limited supply of 2.0%s, and are the most negatively convex. The Fed has consequently improved the quality of the overall MBS float.

Exhibit 1: UMBS QE4 purchases were concentrated in 2.5%s and 3.0%s

Note: Sorted from highest to lowest. Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

Likely to help the dollar roll in 30-year 2.5%s

The most dramatic effect is on the float of UMBS 2.5%s (Exhibit 2). The Fed bought almost as many 2.5%s and 3.0%s, but the float of 2.5%s was much smaller. The Fed has bought almost 55% of the float in that coupon.  And most of that coupon is still available since there has been little production of spec pools or usage of that coupon in CMOs.  This also raises the likelihood that the 2.5% roll will trade special.

Exhibit 2: The Fed removed 55% of the float in UMBS 2.5%s

Note: The % of that coupon’s float removed by the Fed’s QE4 purchasing.  The float is measured before QE4 and removes any pools owned by the Fed, in CMOs, or in spec pools at the start of QE4. Sorted from highest to lowest.  Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

The Fed’s buying has removed some of the worse 3.0% UMBS pools.  The Fed’s purchases have averaged five months of seasoning, right on the cusp of when significant restrictions against refinancing are lifted.  Loans can prepay extremely quickly in the 6 to 12 WALA band. Fed loans, at an average size of $344,000, are also larger than the average of the float.  The float averages $307,000, and is roughly $320,000 for the 2019 and 2020 vintages.  A similar pattern, although not as pronounced, can be seen in their 3.5% purchases—the pools tend to have higher average loan sizes and are at a seasoning that tends to pose a lot of prepayment risk.  The trailing 1-month and 3-month CPRs for their purchases highlight that these pools prepaid much faster than the pools left in the float.

Exhibit 3: UMBS 30-year

Note: Spec pools include pools with a maximum loan size up to $200,000, low FICO pools, high LTV, 100% investor, 100% New York, 100% Puerto Rico, and 100% Texas.  Ginnie Mae spec pools also include 100% Rural Housing and 100% Public Indian Housing pools. Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

Exhibit 4: Ginnie Mae 30-year

Note: Spec pools include pools with a maximum loan size up to $200,000, low FICO pools, high LTV, 100% investor, 100% New York, 100% Puerto Rico, and 100% Texas.  Ginnie Mae spec pools also include 100% Rural Housing and 100% Public Indian Housing pools. Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

Exhibit 5: UMBS 15-year

Note: Spec pools include pools with a maximum loan size up to $200,000, low FICO pools, high LTV, 100% investor, 100% New York, 100% Puerto Rico, and 100% Texas.  Ginnie Mae spec pools also include 100% Rural Housing and 100% Public Indian Housing pools. Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

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