By the Numbers
Lower coupons lead MBS returns through July
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.
Investor demand for lower coupon MBS jumped in late June and July, pulling year-to-date returns into positive territory for 30-year 3.0%s and 3.5%s. Much of the demand came from money managers that had been underweight those coupons for the last two years. In conventional MBS, only 5.0%s failed to outperform hedges in July. Lower coupon Ginnie Mae MBS also performed best in July, and the 3.0% and 3.5% coupons also turned positive for the year. However, Ginnie Mae 4.5%s and 5.0%s each underperformed hedges and posted lower excess returns than their conventional counterparts. Banks continue to buy Ginnie Mae MBS, so returns may be more dependable than conventional MBS that rely on money managers.
In conventional MBS, year-to-date returns are still negative in 30-year 2.5%s and lower coupons despite heavy buying in June and July. For example, 2.5%s earned 1.70% in July yet still have 0.55% underperformed hedges for the year. Monthly returns topped 1.5% for every coupon below 3.5%s. Performance dipped for higher coupons but remained positive, apart from 5%s. Money managers are the primary buyer of conventional MBS—the Fed has scaled back purchases and will likely stop buying MBS in September, and banks are focused on Ginnie Mae MBS. This should make conventional returns more volatile and money managers look for the best relative value in and out of MBS.
Exhibit 1. Conventional MBS excess returns (%)
Excess returns reported by the Bloomberg Barclays MBS Index.
Source: Bloomberg, Amherst Pierpont Securities
Ginnie Mae MBS also had strong returns in most coupons, slightly above conventional in 3.0%s and below. However, Ginnie 4.5%s and 5.0%s underperformed hedges. This might reflect increasing concerns about the FHA lowering mortgage insurance premiums, which officials have stated is under consideration. Most of the Ginnie Mae market is priced far enough below par that MIP cuts would not lower MBS prices. But new production 4.5%s and 5% pools would likely prepay much faster as borrowers refinance to take advantage of lower premiums.
Exhibit 2. Ginnie Mae MBS excess returns (%)
Excess returns reported by the Bloomberg Barclays MBS Index.
Source: Bloomberg, Amherst Pierpont Securities
Exhibit 3. Conventional MBS excess returns have favored higher coupons
Excess returns reported by the Bloomberg Barclays MBS index. Excess returns are cumulative starting January 1.
Source: Bloomberg, Amherst Pierpont Securities
Although concern about recession should keep MBS excess returns ahead of those in credit, MBS spreads to the Treasury curve have tightened significantly in recent weeks and look likely to correct. The best opportunity to tactically go short the MBS-to-Treasury basis is in 30-year 2.0%s.
Brian Landy, CFA
blandy@santander.us
1 (646) 776-7795
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