By the Numbers
Up-in-coupon continues to lead the way for MBS returns
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Conventional 30-year MBS have outperformed hedges over the last three months, according to the Bloomberg Barclays MBS Index. Excess returns started improving in August with coupons 4.0% and higher leading the way. The outperformance subsequently spread to 3.0%s and 3.5%s. Ginnie Mae MBS have also generated positive excess returns across the coupon stack since August. But Ginnies have not favored higher coupons to the same degree as conventionals. Investors may be anticipating that Fed tapering will have a larger effect on conventional MBS than it will on Ginnie Mae MBS.
Conventional and Ginnie Mae 2.5%s have generally performed in-line with hedges for the last few months (Exhibit 1). The graphs plot cumulative excess returns starting from July 1. However conventional 2.0%s have generally underperformed hedges. This was true of Ginnie Mae 2.0%s until August, after which performance began to improve. And Ginnie 2.0%s returns jumped markedly in late September. Meanwhile conventional 3.0%s and 3.5%s have performed much better than Ginnie Mae MBS, although even the Ginnies have generated positive excess returns over the last month. Of course, these returns do not reflect gains from persistently special dollar rolls in lower coupons.
Exhibit 1. Conventional MBS excess returns have favored higher coupons
Excess returns reported by the Bloomberg Barclays MBS index. Excess returns are cumulative starting July 1.
Source: Bloomberg, Amherst Pierpont Securities
Option-adjusted spreads show a similar story. Conventional and Ginnie Mae OASs have been nearly identical in the 2.5% coupon. But Ginnie 2.0% OASs have tightened more than conventional OASs over the last few months. Ginnie 3.5% OASs were roughly the same as conventional OASs at the start of July but are now roughly 15 bp wider. And Ginnie 3.0% OASs have widened relative to conventionals’ since the beginning of October.
Exhibit 2. Conventional and Ginnie Mae MBS OASs
OASs from Bloomberg’s BAM prepayment model.
Source: Bloomberg, Amherst Pierpont Securities
Conventional investors are likely moving up-in-coupon in preparation for Fed tapering. The Fed is only buying 2.0% and 2.5% 30-year MBS, so those are most likely to weaken when tapering starts. But the shift up-in-coupon has not been as strong in Ginnie Mae MBS. This could be due to net supply, which has been extremely high in conventional MBS but very low in Ginnie Mae MBS. And some investors have fewer investment alternatives to Ginnie Mae MBS, which are backed by the full faith and credit of the US government and carry a 0% risk-weighting for banks.
The recent outperformance has pushed MBS returns positive for the year in coupons 3.0% and higher, although the aggregate index return remains negative due to the heavy weight towards lower coupons (Exhibit 3). And these returns do not reflect dollar rolls, which have traded special in 2.5% and lower coupons. That adds substantially to performance for portfolios that can roll their TBA positions. Excess returns on Ginnie Mae MBS are still negative for the year, despite the recent improvement (Exhibit 4).
Exhibit 3. Conventional MBS excess returns (%)
Excess returns reported by the Bloomberg Barclays MBS index.
Source: Bloomberg, Amherst Pierpont Securities
Exhibit 4. Ginnie Mae MBS excess returns (%)
Excess returns reported by the Bloomberg Barclays MBS index.
Source: Bloomberg, Amherst Pierpont Securities
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