Written by Darren Stumberger, as originally published in The Reverse Review.

 

HMBS spreads continue to march wider into the fourth quarter with no near-term catalysts to flip the script. Fixed-rate HMBS spreads are now at 90 after touching 35 to swaps earlier in the year. One-month Libor/10 percent cap loans are at 80 discount margin (DM) versus 35 DM in the spring, and annual Libor is touching 40 DM versus its forming spot in the mid-teens.

Summertime market volatility brought on by plunging commodity prices, China’s equity market rut and global growth concerns caused many securitized product investors to move to the sidelines. In addition, many banks typically do their buying in the first half of the year. Without bank sponsorship, demand for HMBS and HREMIC floaters tend to dry up, causing secondary market spreads to widen. The Street is heavy with paper heading into Q4, and coupled with year-end balance sheet pressure, spreads should continue marching wider into 2016.

Prepayments on HECMs have been mostly volatile and erratic since the principal limit factor change in August 2014. Large numbers of HECM-to-HECM refinances (due to the FHA program change) on the 2013 HECM 60 vintage firmly place this vintage as the worst-performing ever. Partial prepayments on newly originated floating-rate loans also continue to plague the sector, whereas loan officers and brokers exchange the elimination of closing costs for drawing more line of credit than they would otherwise have at closing (and then coaching the consumer to pay back the funds shortly thereafter in subsequent months).

Also, there’s been an uptick in prepayments for seasoned loans due to more aggressive servicing procedures. So, the purity of the HECM prepayment story that has been welcomed by investors since 2009 has been put to the test. Security and originator/GNMA issuer selection is paramount to sidestepping land mines and finding value in the sector.

To date, there’s been roughly $6.7 billion in HMBS issuance in 2015, with about $6.5 billion of that being structured into HREMICs. Since program inception, the best execution for floating HMBS has been stripping coupon into a par-priced floater with corresponding WAC (weighted average coupon) IO (Interest Only class). With the market shifting to 80-90 percent floating-rate origination, this trend will continue (i.e., HREMIC execution). Nomura has been the lead HREMIC structurer to date in 2015 with $2.4 billion in deals brought to market. BAML, which has maintained a first-place position in HECM-structured deals since 2005, is close behind at $2.1 billion. Credit Suisse and Barclays round out the league table. In HMBS issuance terms, six issuers comprise 90 percent of volume. AAG, RMS, Urban, RMF, Live Well and Liberty have issued just over $6 billion in loans and tails in 2015 thus far, and as an industry we should get within striking distance of $10 billion for the year.