FLASH UPDATE: TRV Weekly Commentary - Rates Approaching All-Time Lows

TRV Weekly Commentary
Week Ending 04 Feb 2015

Comment:

The rates market appears relatively calm on a week-to-week basis; we saw the curve bear steepen by 2 basis points with mortgages relatively flat versus the curve. Rates however whipsawed drastically around month-end with 10yr yields falling within inches of an all-time low. Swap volumes were running about 200 percent above average with flows skewed toward receiving across the curve. The catalyst for the market actively was largely a disappointing Q4 GDP print (2.6% versus 3.0% expectations) and Russia’s surprise decision to cut rates by 200 bps. The benchmark 10yr ultimately snapped back 11 basis points to yield 1.75% in the days following the turmoil.

Mortgages lightly underperformed rates across the coupon stack into month-end as origination picked up. We saw quite a few days of 3+ bln in issuance in tandem with low rates. Mortgages later rallied between a half to 2.5 ticks before ending relatively flat. We would like to point out that the G2/FN 4 swap fell drastically following the FHA’s announcement that it would reduce the Mortgage Insurance Premium (MIP) by 50 basis points. In our opinion, the swap was over chastened and has rallied 5 ticks from an intraday low of -17 ticks. We continue to follow the swap’s performance.

The refi index increased 2.5% this week despite recent declines in Treasury yields. The MBA 30 year mortgage rate decline a mere 4 bps, helping to suppress the refi index. The real refi story is that FHA refi applications picked up 76% on a seasonally adjusted basis due to the MIP decrease. The surge in applications is likely due to pent-up demand as servicers ramp up their solicitation efforts. We note that servicers are not at capacity as staffing levels are little changed from late 2012 when the refi index was much higher. Additionally, we would look to primary/secondary spread widening as early signs of capacity constraints, yet the spread has remained relatively range bound.

As the FHFA contemplates reducing principal on properties with depressed values as approximately 10% of homeowners have negative equity, policy risk remains high. Additionally, investors are also focused on a potential HARP extension. We estimate that $91 bln of loans have LTVs greater than 80 and have more than 100 bps of rate incentive. A year ago, that number was only $42 bln when Mel Watt said HARP extension was off the table. The HARP extension thus seems more plausible and would likely cause significant widening of eligible collateral.

The resulting increased refi risk continues to cause IO OAS to widen. The chart below shows that vintage is an extremely relevant as 3.5s of ’13 have a much higher risk premium than do 3.5s of ’12. We also note that 4s of ’13 continue to have the highest risk premium as they have the greatest rate incentive, are less seasoned and are less prone to refi burnout. The recent widening has presented significant opportunity in the space and we anticipate volatility and policy risk will continue to drive our markets.

Regards,

Tradex Global Advisory Services, LLC

investorrelations@thetradexgroup.com 

203-863-1500

@Tradex_Global