By the Numbers

MBS trails its hedges in August, but still up on the year

Brian Landy, CFA | September 8, 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.

MBS underperformed the Treasury curve in August, ending a stretch of outperformance that began in the spring. Excess returns went negative across most of the coupon stack, although higher coupons took less of a hit than lower coupons and 30-year 6.0%s even outperformed hedges. Ginnie Mae and conventional 15-year MBS also posted negative excess returns in most coupons. Mortgage performance remains positive for the year in most conventional and Ginnie Mae 30-year coupons, but 15-year MBS have generally underperformed for the year. Low loan balance specified pools in low coupons also fared poorly in August, despite desirable prepay behavior.

Conventional 30-year MBS underperformed Treasury hedges across most of the coupon stack in August (Exhibit 1). The 4%s coupons and lower underperformed by at least 35 bp, with the 3%s handing in the worst performance at −52 bp. However, mortgages have outperformed Treasuries for much of the year, which has kept year-to-date returns positive. Mortgages started the year strong, then performance suffered in March and April as the regional banking crisis unfolded. But mortgages rebounded in April and May and held strong through the end of July.

Exhibit 1. Conventional 30-year MBS excess returns (%)

Excess returns reported by the Bloomberg Barclays MBS Index, through 8/31/2023.
Source: Bloomberg, Santander US Capital Markets

The underperformance is reflected mortgage option-adjusted spread (Exhibit 2). The table shows the Treasury OASs for mortgage TBAs from 1.5% through 6.0%. Most coupons widened 4 bp to 6 bp. The 6.0%s tightened slightly, consistent with the small outperformance of that coupon.

Exhibit 2. Conventional 30-year Treasury OASs widened least in 1.5%s, 5.5%s and 6%s.

Source: Bloomberg, Santander US Capital Markets

Certain specified pool types widened more than the corresponding TBA in August (Exhibit 3). This table is pulled from the group of index-eligible cohorts with at least $5 billion outstanding balance. The difference between its OAS and the TBA OAS is calculated for each cohort at the end of July and the end of August, and the cohorts are ranked by the changed in that value. The table shows the 10 cohorts that widened the most compared to the TBA, and the 10 cohorts that widened the least, or tightened, compared to the TBA.

Exhibit 3. Low coupon, low loan balance, specified pools widened vs TBA.

The “OCC” cohort includes pools that include only investment properties and second homes.
Source: Bloomberg, Santander US Capital Markets

Many of the worst-performing cohorts were 2.0% and 2.5% low loan balance cohorts issued in 2020 and 2021. The group of 10 is rounded out by a few seasoned vintage cohorts. These cohorts widened by 5 bp to 7.5 bp. The table also compares each cohort’s prepayment speed to the corresponding TBA cohort’s speed over the last six months. Each specified pool cohort is prepaying faster than its TBA cohort, which is a positive for since these cohorts are trading at a discount to par. So, the underperformance came despite the extension protection afforded by the faster prepayment speeds.

The bottom half of the table shows 10 cohorts that tightened to TBA. This group includes mostly recent vintage pools with a mix of lower and higher coupons. Many have geography stories—100% Florida, New York, and Texas. However, for most of these cohorts the spread tightening was low—the underperforming group widened a lot more than the outperforming group tightened,

Ginnie Mae 30-year MBS also underperformed Treasury hedges in August (Exhibit 4). Like conventional MBS, excess returns were negative in all but the 6.0% coupon. Year-to-date performance is positive for 4.0%s and below but has turned negative for 4.5%s through 5.5%s. Performance in those coupons was weaker earlier this year as investors were concerned about the prospect for, and effect of, lower FHA mortgage insurance premiums.

Exhibit 4. Ginnie Mae 30-year MBS excess returns (%)

Excess returns reported by the Bloomberg Barclays MBS Index, through 8/31/2023.
Source: Bloomberg, Santander US Capital Markets

Conventional 15-year excess returns were negative across the stack (Exhibit 5). Unlike 30-year MBS, the best performing coupons were 2.5%s and 3.0%s. These are also the only two coupons with positive excess returns this year. The MBS portfolio the FDIC acquired from Silicon Valley Bank and Signature Bank was overweight 15-year MBS and most was in 3.0% and lower coupons. Those lists were generally well received by investors but may have reduced interest in other coupons.

Exhibit 5. Conventional 15-year MBS excess returns (%)

Excess returns reported by the Bloomberg Barclays MBS Index, through 8/31/2023.
Source: Bloomberg, Santander US Capital Markets

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

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