Uncategorized

The Fed keeps cleaning up TBA

admin | July 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.

With $890 billion of MBS in Fed hands since mid-March and another $40 billion heading that way monthly, the Fed continues to improve the quality of deliverable TBA pass-throughs. The Fed has removed some of the largest loan balances and worst convexity from the market by taking delivery of TBA trades and concentrating its purchasing in the most negatively convex coupons. But filtering out negative convexity and helping keep TBA dollar rolls special has also kept pressure on pay-ups for specified pools.

Improving the quality and OAS of the TBA float

One way to illustrate that the Fed has removed worse collateral from the 30-year MBS market is to calculate OASs first for pools that represent the average characteristics of the Fed’s purchases and then for all other MBS pools after excluding CMO holdings and specified pools (Exhibit 1). Each pool is run at that coupon’s TBA price. The Fed’s OASs range from 6 bp tighter in 2.0%s and 2.5%s to 60 bp tighter in 3.0%s.

Exhibit 1: The Fed buys pools at tight OASs

Note: OASs calculated as of 7/20/2020 using Yield Book’s experimental model using collateral attributes shown in Exhibit 4. Source: Yield Book, Amherst Pierpont Securities

The Fed’s portfolio mix and share of the float

Almost 70% of the purchases have been in 30-year 2.5%s and 3.0%s (Exhibit 2), but over the last two months the Fed has also bought a significant amount of 2.0%s. The Fed has not bought coupons greater than 3.0% since May 8, and the 2.0% coupon was 40% of their overall buying in July. This shift to lower coupons is a response to increasing production of that coupon as originators have tightened the difference between primary and secondary spreads to maintain origination volumes. The Fed has the greatest influence on mortgage rates by concentrating purchases in production coupons.

Exhibit 2: UMBS QE4 purchases were concentrated in 2.5%s and 3.0%s

Note: Sorted from highest to lowest, data through 7/29/2020. Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

The Fed ‘s buying has removed roughly 50% of the total float in 30-year 2.5%s and close to 40% of the float of 2.0%s (Exhibit 3). The heavy Fed activity in these coupons, and in 3.0%s, has contributed to those rolls trading special since the Fed increases aggregate demand to buy TBAs and improves the TBA price by removing worse convexity pools from the float.

Exhibit 3: Fed buying has had the largest effect on 2.0%s and 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

Taking higher loan balances out of the float

The Fed has bought pools that are consistently higher average loan size than the remaining float and generally higher than 2019 and 2020 vintage float (Exhibit 4). For example, purchases in 30-year 2.5%s had an average loan size of $347,000 compared to $320,000 for the float—after removing specified pools and pools in CMOs—and $321,000 for the remaining 2020 vintage. The one small exception is their purchases in 4.0%s have roughly the same loan size as the small amount of 2020 production.

The Fed’s 3.0% pools should prepay much faster over the coming months, assuming rates do not move higher. These pools have benefitted from slower prepayments speeds typical of newly originated loans. However, these pools are currently 7 WALA and that prepay protection should rapidly vanish.

Valuation impact

The improving quality of TBA should broadly improve the performance of MBS against other assets by reducing the negative convexity of the market. A better TBA also starts to close the convexity gap to specified pools, reducing the relative value of the specified market. By taking delivery on TBA trades, the Fed has also helped keep dollar rolls special in coupons with heavy Fed buying. The special rolls further reduce the difference in monthly carry between TBA and specified pools, another source of pressure on specified pool pay-ups.

Exhibit 4: UMBS 30-year

Note: The float includes 20-year MBS as non-specified collateral since there is currently no pay-up for these pools and prepayment speeds have been very fast. Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

Exhibit 5: Ginnie Mae 30-year

Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

Exhibit 6: UMBS 15-year

Source: Federal Reserve, Fannie Mae, Freddie Mac, Ginnie Mae, eMBS, Amherst Pierpont Securities

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.