The Federal Housing Authority (FHA) is set to launch a hybrid ARM program that would include 3/1s, 5/1s 7/1s and 10/1s. Analysts say that it has little to no current relevance for GNMA fixed-rate relative value as the earliest possible implementation date of the program is September 2003.

Ted Foster, vice president of MBS at Ginnie Mae, said that the specifics of the FHA hybrid program have not been ironed out. "My understanding is that most of the details are worked out except for the 5/1s," said Foster. He explained that it is not yet definite what the cap on the first adjustment would be on this type of hybrid. "So there is still an outstanding question on the underlying collateral," he said. However, he stated that the Veterans Administration (VA) already has a hybrid ARM in place that will be implemented Oct. 1, 2004. The VA will be issuing a 3/1 hybrid.

This will help more people move into FHA/VA loans. "I think it enhances the underlying FHA/VA program," said Foster. "There should be more borrowers that could get into FHA/VA because they have this hybrid option that should be priced slightly better."

Analysts said that until they see the exact criteria for FHA ARMs, it is impossible to say whether they are similar enough to other instruments in the market to attract borrowers. Specifically, people need to know what sort of insurance premium will be associated with the new product. "It could be that they offer the same kind of mortgage instrument that the private sector is providing," said one analyst. "But they might charge double the premium compared to conventionals. It will boil down to what the monthly payment is, which is determined in part by the cost of the mortgage insurance premium."

No immediate market impact

Though there has been some market discussion on the FHA hybrid program, it is of little- to-no current relevance for GNMA fixed-rate relative value, according to analysts from JPMorgan Securities.

For one, the implementation date is too far into the future to have an immediate market impact (as mentioned earlier, the September 2003 is the earliest date when lending could start, though market observers predict that the program would most likely start in the beginning of 2004).

"Its impact at that point would be hard to gauge because we could be in a completely different rate environment a year from now," said an MBS analyst. Further, the refinancing wave might have ended by then. This would mean that there would be less issuance in this product, where there might not be a whole lot of issuance to begin with.

The analyst explained that GNMA hybrids could be more attractive to the FHA purchase borrower, and may not be as attractive to borrowers who intend to refinance because a lot of them refinance into conventionals anyway.

Though the program is going to lower the upfront costs for FHA borrowers allowing them to avail of lower hybrid ARM rates - assuming that rates remain where they are currently when the program actually begins - he believes that it not going to attract the same percentage of borrowers compared to conventional product, especially compared to the amount of jumbo borrowers that are going into hybrids. Hybrid borrowers usually have larger loan sizes and tend to be the more affluent ones. They also have a shorter horizon, which is exactly the opposite of the typical FHA borrower. "I don't expect a lot of the FHA borrowers to go into hybrids because they tend to have a little bit longer horizons," said the analyst.

Further, Ginnie Mae is actually currently offering an ARM product that is very attractive so if the GNMA borrowers want to lower their rates by going into an ARM, they could actually go into Ginnie ARMs. Besides, there is not much of a market for this product.

In other words, the hybrid product will not have a significant impact on the market because if GNMA borrowers want to refinance they could move into conventionals; or if they want to lower their monthly payment, they could go into a Ginnie ARM.

Futhermore, though the FHA hybrid will mostly likely impact the composition of the GNMA universe going forward, analysts expect that it is going to take away only a very small share of the GNMA purchase market.

Moreover, it is not clear how FHA hybrids would trade and how much of a secondary market would develop for this type of product that has no existing float or history. Observers predict that it would be very slow in developing, so the program would probably not be able to offer very attractive rates to FHA borrowers initially.

Deutsche research

In recent research, Deutsche Bank analysts said that the proposed FHA hybrid program would be bullish for the GNMA 30-year and 15-year lower coupon passthroughs. The different hybrid products under the program would probably lure some borrowers from these programs, thus decreasing supply. They noted that most GNMA borrowers are first- time homeowners, so this means that a 5/1 or a 7/1 ARM would fit their borrower profile well. This would also allow Ginnie Mae the flexibility of specifying the adjustment date (within six months) for FHA ARMs that go into Ginnie securities.

Deustche added that the development of a Ginnie Mae hybrid program could actually increase the prepayment speeds on higher coupon Ginnies, such as 6.5s in the later part of this year. Ginnie borrowers would have a new product to refinance into which was not available to them previously, thus making prepayment speeds faster through the streamlined refinancing program. They also said that in Ginnie Mae's version of the program, only the mortgage payment needs to go down. This would mean that no appraisal of the property or borrower credit/ employment checks are performed. Conventional borrowers have had hybrid ARMs (or balloons) available for more than 10 years now.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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