FLASH UPDATE: TRV Weekly Commentary

TRV Weekly Commentary
Week Ending 30 Sep 2014

Comment:

The yield curve continued to bull flatten as the 10/5 spread fell another 4 bps to 73.3. To put recent flattening into prospective, the 10/5 spread was 122.7 bps exactly one year ago. Given the global economic backdrop, our opinion is that the yield curve could very well flatten into a rate hike cycle. Mortgages’ performance was in line with their 5yr hedges but could not keep pace with the 10yr rally. Implied volatility on the 1Mx10Yr swaption also ticked up 6 bps last week as Bill Gross’s departure from PIMCO gave investors a lot to digest.

The Refi index fell another 4 points to 1294 as refis currently account for 56% of total mortgage applications. We expect this percentage to fall into a rate hike cycle and increased burnout. It is estimated that 36% of the loan universe has both the necessary equity and rate incentive to refinance. As we enter a period of declining refi activity, spec pools may counterintuitively provide extension protection.

Per se, we note that high LTV pools with rate incentives may provide extension protection as HPA increases and home equity builds. There were some sizeable movements in spec pool payups this week, particularly in cuspy loan balance FN 4.0s. HLB 4s, for example, fell 13 ticks this week to 0-10+ over TBA prices while LLB 4s fell 10 ticks to 0-23 over TBAs. We view these valuations as attractive with HLB 4 and LLB 4 payups trading at 21% and 34% of their theoretical payups, respectively. We derive theoretical payups by running the spec cohort at TBA OASs.

Benchmark IO OASs continued to tighten this week, with FN 4.5s of 10 tightening 12 bps and FN 4.5s of 11 tightening 11 bps. In comparison, IO 4s of 10 and 11 tightened only 2 basis points. Despite yield curve flattening and increased volatility, investors continue to price in lower prepayments for high coupon IOs.

Noteworthy:

MBS correlations to CDX IG have spiked to six-month highs. Higher correlations have historically preceded a reversal and we consider this possibility given recent tightening and a decreasing Fed takedown.

Regards,

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global