By the Numbers

Up-in-coupon starts to lead MBS returns

| August 13, 2021

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.

Higher coupon 30-year MBS have outperformed hedges so far in August, according to the Bloomberg Barclays MBS Index. Conventional 4.0%s through 5.0%s have turned in the strongest performance, with excess returns slightly above 0.5% in each coupon. The picture is similar in Ginnie Mae MBS, where all coupons 3.0% and higher have beaten hedges in August. Investors may be encouraged by the June and July prepayment reports, which suggest burnout is developing in higher coupon pools. The same coupons should also do well in a Fed taper when spreads stand to soften, but that should have less effect on the most premium pools.

The conventional MBS index has generally underperformed hedges, reflecting heavy weighting toward lower coupons (Exhibit 1). These results do not reflect dollar rolls, of course, which have added substantially to returns for portfolios that can use the roll market. But over the last 12 months, the MBS index underperformed hedges by 0.39%. Underperformance has been particularly sharp in 2021. For example, excess returns have been -0.55% year-to-date, -1.04% over the last six months and -0.88% over the last three months. But in August MBS has done much better, only underperforming so far by 0.08%.

Exhibit 1. Conventional 30-year MBS returns have improved greatly in August

Excess returns reported by the Bloomberg Barclays MBS index. Source: Bloomberg, Amherst Pierpont Securities

Higher coupons have generally done better than lower coupons across all the listed horizons. When the whole stack underperformed hedges, such as over the last three and six months, higher coupons did not underperform as much. And in August, excess returns on the higher coupons have turned positive. This could reflect investors shifting into those coupons to prepare for the Fed to taper its MBS purchases, which should widen MBS spreads. Higher coupon MBS typically have lower spread duration and should not be as effected. Recent prepayment reports have been positive for higher coupon pools, too, showing signs of burnout and improving convexity.

Ginnie Mae MBS are showing similar behavior in August (Exhibit 2). The index overall has slightly outperformed hedges, and most of this comes from 4.0% and higher coupon pools. Meanwhile the 2.0% and 2.5% coupons, excluding any special financing, have still underperformed hedges.

Exhibit 2. Ginnie Mae 30-year MBS returns also improved in August

Excess returns reported by the Bloomberg Barclays MBS index. Source: Bloomberg, Amherst Pierpont Securities

Brian Landy, CFA
brian.landy@santander.us
1 (646) 776-7795

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