Did you hear we now have a podcast series? Well, we do and it’s called, The Community Bank Podcast. Though the title may not be super-catchy we thought it a good descriptor of what the podcast will be focused on. It was created with the idea to help community bankers grow themselves, their team, and their profits, and it’s all brought to you by the Correspondent Division of CenterState Bank. The most recent episode, we think, is very timely as we sit down with two of our sales professionals, Todd Patrick and Todd Davis, and discuss how banks should be thinking about their investment portfolios as we work our way from a once vibrant economy through the economic crisis caused by the pandemic. We also have a customer interview so you can hear from a fellow community banker and what he is doing with his bank’s investment portfolio today. Give it a listen, and better yet subscribe so you don’t miss a future episode. The itunes link can be found here and the Spotify link here.
A combination of good news on a virus treatment and a retail sales report that doubled expectations laid the groundwork for a risk-on rally yesterday and that continued even with Fed Chair Powell reprising his FOMC concerns to the Senate Banking Committee in the first of two days on Capitol Hill testimony. The drug news involved a UK study of a 60-year old medicine, dexamethasone. The steroid treatment was found to reduce deaths by a third in patients on ventilators, and by a fifth for those receiving oxygen. The fact that it’s an existing, and relatively inexpensive, drug will probably speed its use in treatments.
The retail sales numbers for May were another big risk-on catalyst as the growth in sales was double the already lofty expectations and the V-shaped crowd will undoubtedly cheer the results. Like almost all May reports the numbers are a big improvement on truly ugly April results, but the degree of the retail sales beat for May surprised almost all market watchers. Overall sales increased 17.7% month-over-month which represents the largest monthly gain in the series that dates back to 1992.
The May gain compares to expectations that were calling for a more subdued rebound of 8.4%, and it also wipes out the -14.7% decline in April sales. Similarly strong numbers were posted in the other sub-indices with the Control Group--a direct GDP feed--bouncing by 11.0% versus 5.2% expected and –12.4% in April. In all, this report indicates consumers returned to stores and restaurants in droves and that bodes well for a slightly less negative second quarter GDP. Now if we can keep the virus count at bay and keep them shopping.
How to Slow the Prepayment Train
We mentioned our new podcast series earlier and one of the topics in the latest episode, “Adjusting Your Investment Strategy in 2020” the panel discussed the issue of increasing prepayments in mortgage-backed securities and how to minimize that risk. It was an interesting discussion and we encourage you to listen to the full episode, but we wanted to hit on a few key points in this space.
- Forbearance Isn’t Slowing Speeds Yet –We had surmised a couple months ago that the forbearance programs provided to distressed borrowers in the CARES Act would probably slow prepayments as servicers would defer foreclosure actions for up to 12 months for affected borrowers. Even though more than 8% of borrowers have opted into the forbearance program in the first two months, prepayment speeds continue to surprise to the upside. The May speeds were only fractionally lower than the very fast April speeds as lower mortgage rates and reopening economies more than offset any slowing brought on by the forbearance programs, at least so far.
- Prepayment Speeds Continue to Surprise to the Upside– As we mentioned above, prepayment speeds have consistently been coming in above expectations and while some slowing was thought would happen via lockdowns and forbearance programs we really aren’t seeing it in the numbers. Despite the uptick in virus cases, as reopenings continue and the summer selling season now upon us, we expect prepayment speeds to continue to be fast, faster and fastest.
- Call Protection is King– As prepays are expected to be high, if not continue higher, looking for ways to protect your premium bonds from excessive amortization stemming from faster prepays seems to be job 1 for the investment portfolio manager overseeing the MBS sector. Specified pools have become an effective way to manage this risk. These are pools that have a limit on individual loan size and they vary from low loan balances of $85,000 or less, to $200,000 max loan sizes with several iterations in between. Borrowers with low balances won’t see as dramatic interest savings from the laborious refinance process as a higher balance borrower would. Plus, the mortgage broker isn’t compensated as much on a low balance loan versus say a jumbo loan so which do you think he’ll focus on? And shepherding a low loan balance through underwriting can be just as time-consuming as the larger loan, if not more. Thus, low loan balance pools often have slower speeds versus similar coupon, larger balance loans.
- Swapping into Specified Pools– With the dramatic drop in rates this year, even pools bought last year can be susceptible to increasing prepayments, especially 3.5% coupon pools that were very popular this time last year. Swapping out of more prepay-susceptible pools into specified pools has been a very popular trade in recent weeks and is likely to continue as speeds look to accelerate through the summer months. If you would like to have your MBS sector examined for pools with a higher likelihood of increasing prepays contact your CenterState Bank representative to begin the analysis and perhaps propose a swap out higher risk pools into more prepay-resistant specified pools.
Agency Indications — FNMA / FHLMC Callable Rates
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