By the Numbers
Primary mortgage rate spreads jump
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Yields for many fixed-income products have fallen since the beginning of the SVB stress. But mortgage rates have not fallen as much as rates for other products. The current coupon for agency MBS from March 8 to March 22 dropped 69 bp, but the primary mortgage rate over the same period fell only 37 bp. High market volatility has made it more expensive for originators to hedge pipeline risk, and originators increased margins to cover those costs. Mortgage rates likely need to fall below 5.5% to entice many 2022 vintage borrowers to refinance. But spreads could tighten quickly if volatility falls, since lenders are struggling with low origination volumes.
The mortgage primary-secondary spread jumped over last two weeks (Exhibit 1). That spread had fallen below 100 bp in early 2023 but has widened over 30 bp since March 8. However, the spread is still a little below the levels experienced in 2021 and some of 2022, likely because originators are under pressure from low demand for mortgages.
Exhibit 1: Primary-secondary spreads widened nearly 30 bp since SVB failed
The mortgage primary rate uses Optimal Blue’s mortgage rate lock index for agency-conforming loans with at least 740 credit scores and no more than 80 LTV.
Source: Optimal Blue, LLC., Yield Book, Santander US Capital Markets.
Mortgage originators hedge the risk that a borrower walks away from a rate lock if mortgage rates fall. The barriers to walking away are typically low, so this risk carries significant negative convexity for the originator. The cost of hedging pipelines goes up when volatility is high. And many correspondent lenders were quick to boost margins themselves, causing some lenders to stop buying loans from the correspondent channel.
The primary-secondary mortgage rate spread increased more for jumbo and FHA borrowers than for conventional borrowers (Exhibit 2). Each line represents the spread between the prevailing mortgage rate for that product and the mortgage rate for a 740 FICO 80 LTV loan. The jumbo-to-conforming spread jumped almost 20 bp, although has become quite volatile due to limited jumbo loan production. The jumbo data also incorporates non-QM loans, which introduces some noise as the mix of jumbo and non-QM loans can change over time.
Exhibit 2: Mortgage primary rate spreads relative to the conforming mortgage rate
Each line represents the spread between that product’s mortgage rate and the rate for an agency-conforming loan with at least 740 credit score and no more than 80 LTV. All rates are use Optimal Blue’s mortgage rate lock indices.
Source: Optimal Blue, LLC., Yield Book, Santander US Capital Markets.
The FHA-to-conforming rate spread also increased, by more than 10 bp. Lenders may perceive these loans as riskier since they are typically low-credit borrowers that make small down payments. Although the loans are insured by the FHA, servicers face some loss when loans default. On the other hand, the VA-to-conforming rate spread held steady over the last two weeks, likely reflecting the better credit quality of those borrowers.
Mortgage spreads also widened more for low FICO conventional borrowers (Exhibit 3). Each line compares the primary rate for borrowers in different credit score buckets to the primary rate for loans with at least 740 FICO scores. The rate spread jumped the most—close to 15 bp—for the 680 to 700 FICO bucket, but only increased 5 bp to 10 bp for borrowers with credit scores between 700 and 740. This suggests that originators are tightening the credit box when the economic outlook worsens.
Exhibit 3: Mortgage spreads widened the most for borrower with low credit scores
Conforming conventional mortgage spreads vs. loans with FICO ≥740. All loans ≤80 LTV.
Source: Optimal Blue, LLC., Yield Book, Santander US Capital Markets
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