By the Numbers

MBS investors shift back to higher coupons

| September 9, 2022

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.

Investors shifted back into higher coupons in August, likely due to growing belief that the Fed will keep aggressively raising rates to combat inflation. Higher coupon MBS lose less value than lower coupon MBS when interest rates increase. Higher coupon MBS also outperform lower coupon MBS when the spread between mortgages and Treasury debt widens, which happened throughout much of August. The Bloomberg Barclays MBS index shows conventional MBS coupons underperformed hedges across the 30-year stack, although tipped slightly positive in 5%s. Ginnie Mae MBS generally fared better than conventional MBS across the stack and generated positive excess returns in 4.5%s and 5.0%s.

The underperformance in August has pulled most coupons’ excess returns firmly into negative territory for the year. Only the 4.5% and 5.0% coupons have generated positive excess returns for the year. Money managers are the primary buyers of conventional MBS, which makes MBS performance more volatile as 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, through 8/31/2022.
Source: Bloomberg, Amherst Pierpont Securities

Ginnie Mae MBS outperformed conventional MBS in August, which has been true for most of the year. Only in 2.0%s has Ginnie MBS posted lower year-to-date excess returns than conventional MBS, and that margin was small. Banks have mostly bought Ginnie Mae MBS, which have lighter capital requirements. This helps banks when losses in available-for-sale securities portfolios cuts into capital. Conventional MBS paydowns were generally reinvested in Ginnie Mae MBS. However, there are indications that some banks are contemplating adding conventional MBS this quarter. That will improve conventional MBS returns if the buying materializes.

Exhibit 2. Ginnie Mae MBS excess returns (%)

Excess returns reported by the Bloomberg Barclays MBS Index, through 8/31/2022.
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

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

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