By the Numbers

Wide bid-ask spreads challenge MBS investors

Brian Landy, CFA | May 5, 2023

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.

The bid-ask spread for TBA MBS has lately reached its highest level in at least two years. This is likely due to lower MBS demand from the Fed and banks, the uncertainty surrounding the viability of certain regional banks and the Federal Deposit Insurance Corporation’s sales of MBS acquired from Silicon Valley Bank and Signature Bank. Investors may find the heavy costs makes it difficult to take advantage of MBS opportunities, like reallocating to different coupons or shifting between 15-year and 30-year MBS.

The bid–ask spread for the current coupon TBA has ranged from 3/32s to 6/32s for most of 2023 (Exhibit 1). The chart shows the bid–ask spread for the MBS coupon priced closest to, but higher than, par. Prior to late 2022, the bid–ask spread was typically around 1/32 and rarely exceeded 2/32s. Anecdotally, this might be the widest bid–ask since the 2008 financial crisis, but unfortunately the data does not go back that far.

Exhibit 1. TBA Bid–Ask spreads are at the widest levels in over two years.

Moving average applied to smooth day-to-day noise. The current coupon bid–ask spread is determined by choosing the spread of the coupon with the lowest price at or above par each day. Data as of 5/3/2023.
Source: Bloomberg, Santander US Capital Markets.

The current coupon spread first widened last spring, around the time the Fed stopped buying agency MBS pools. It widened from roughly 1/32s to 2.5/32s by the end of May, when the Fed started to allow its MBS portfolio to runoff. The spread stayed at that level for a few months, then tightened back to 1/32s until December. The bid–ask widened sharply in December, and then shifted even wider in February as the banking crisis developed, peaking around the time of the Silicon Valley Bank and Signature Bank failures. It narrowed a little after then but has shifted wider over the last couple of weeks as the FDIC began auctioning off pieces of the SVB and Signature MBS portfolios.

Mortgage rates increased sharply in 2022. By September, the MBS current coupon had moved above 5% and ranged from 5% to 6% for most of the time since then. Therefore, the current coupon bid–ask does not reflect movements in lower coupons. But lower coupons’ bid–ask also widened (Exhibit 2). This shows the spread for FNCL 2%s and FNCL 2.5%s, which became less liquid as origination in those coupons dried up. The 2%s spread jumped sharply wider, to over 5/32s, in December and has stayed in that neighborhood since then. The FNCL 2.5% spread increased into the 3/32s to 4/32s area, and occasionally has breached 5/32s.

Exhibit 2. Bid-ask spread for lower coupons have also jumped.

Moving average applied to smooth day-to-day noise. Data as of 5/3/2023.
Source: Bloomberg, Santander US Capital Markets.

The mortgage market is not alone in dealing with a wider bid-ask and other markers of lower liquidity. Liquidity in the Treasury market started eroding in late 2021 as the Fed signaled a hiking cycle and then eroded sharply as the Fed chased inflation through 2022 with a series of 75 bp hikes—hikes that created broad uncertainty about the economy and Fed policy and triggered sharp swings in yields. This shows up clearly in the rising dispersion of intraday yields across on-the-run and off-the-run Treasury issues (Exhibit 3).

Exhibit 3: Rising illiquidity in Treasury debt roughly tracks rising bid-ask in MBS

Note: The index reflects the average difference in yield between US Treasury issues with a 1-year or longer maturity and the intra-day Bloomberg relative value curve fitter. In liquid markets, deviations go away quickly, and index values are low. In illiquid markets, deviations persist, and index values are high.
Source: Bloomberg, Santander US Capital Markets LLC.

The wide bid–ask spread is challenging for MBS investors. Among other things, it becomes more costly to rebalance the coupon exposure of MBS portfolios. Investors might need to do that to track the index, to take advantage of opportunities in different parts of the coupon stack, or to take advantage of dislocations between 15-year and 30-year MBS. The high transaction costs imposed by the wide bid–ask spread can wipe out the profit in some of those trades. It also becomes more costly to trade specified pools at a price spread to TBA since the price of the TBA can vary so widely. In general, wide bid-ask is slowing the reallocation of capital based on risk and relative value and contributing to wider spreads in the sector.

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

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2023 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.