The narrowing in the bid/ask spread in longer-dated California markets (particularly LAX) has been primarily a function of traders offering lower. Those lower offers have also impacted intercity spread quotes, both by narrowing the “arb” level (simultaneous lift one offer in one contract while hitting the bid in another) and by giving IC traders some comfort to narrow their quotes. As a result IC spreads in some longer-dated markets are as tight as I’ve ever seen them.
The table to the right shows a sample of recent IC spreads between the HCI contract (CUS index) and three larger regional contracts. The two-point HCI_LAX X16 IC market of -36.6/-34.6 is the narrowest IC bid/ask spread I can recall on a longer contract in many months. While there are tight markets in both HCIX16 and LAXX16, this IC spread may be of interest to those looking to express a view on the relative value of these two contracts, without taking as much outright risk.
One other point to highlight on the HCI_LAXX16 quote is that if, purely as an example, the spread was traded at -36.6, and #’s such at 206 (for HCI) and 242.6 (for LAX) were used to settle the IC trade, then both components would be ~15.2% over spot level, or about a wash on relative forward performance. This toss-up is a very different state than the last two years when forward California markets have been trading at better implied performance than the CUS 10-city index. For these numbers to give, either home price appreciation will slow in LAX (relative to the CUS index) or other portions of the CUS index (e.g. NYM, BOS, WDC) might have to pick up.
Finally, note that the slowdown in LAX (relative to CUS) does not apply to SFR. The implied percent gains in the HCI_SFR_X16 IC spread are consistent with SFR continuing to outperform the balance of the 10-city index. What makes this curious to me is that some of the rating agencies have punished RMBS deals with San Fran concentrations. Yet, here, this market thinks SFR will do better than the rest of the 10-city index over the next four years. This would seem to open the door to some kind of hedge in RMBS deals to allow San Fran exposure, protect AAA investors, expand the “advance rate” on AAA’s, while taking advantage of the relative bullishness in SFR.
As always, the challenge is that most of these markets are one contract deep (w/ the exception of LAXX16 bid today) and drawing conclusions on such thin markets is iffy. That said, I think that the CME Case Shiller futures, and in particular the IC market, is a great template for having these discussions.
Please feel free to contact me if you have any questions about IC spreads, or care to offer your views. firstname.lastname@example.org