As a result of deteriorating credit, slower home price appreciation and subprime spill-over, Ginnie Mae securities are falling out of favor with Street analysts.
On the credit side, Federal Housing Administration (FHA) delinquencies have been rising. Specifically, 90-plus day delinquencies on FHA loans rose to 3.6% by the end of Q406 from 1.3% in Q198. According to Mortgage Bankers Association statistics, this is slightly above subprime 90-plus delinquencies of 3.3% as of Q406.
However, the increase in delinquencies has not been even across the coupon stack, Lehman Brothers analysts said in a recent report. Lower coupons, for example, have fluctuated at between 3% and 5%, while 6.5s have been at the upper end of that range. Meanwhile, 2004 7s are above 20%, analysts said, while 2005 7s have risen to 19% from 4% in the last year. This trend, however, is not something unexpected, as these borrowers were likely credit-constrained and were unable to refinance into another mortgage. As a result, analysts expect buyouts/delinquencies to occur more in high-coupon pools.
In terms of buyouts, analysts said that issuers are more likely to purchase delinquent loans from high-coupon pools, as there is an economic incentive for them to do so. There is no such incentive for loans that are below market. While GNMA 6s seem to have the highest option cost, without accounting for the likelihood of increased buyout activity, the coupon with the highest option cost is actually 6.5s.
Valuations in lower coupon GNMAs are likely to be depressed as a result of slowing home price appreciation, Lehman analysts said. In addition, GNMAs are more likely to be affected by home price appreciation than FNMAs. Analysts attribute this difference to the mortgage insurance that requires FHA borrowers to pay an upfront fee of 150 basis points as well as to FHA loan assumability.
Given these factors, Lehman analysts are recommending an underweight to GNMA securities. However, for investors looking to be in GNMAs, they suggest 5.5s. They believe the coupon is less overvalued than other coupons. Since it is also trading at a discount, it will not be as affected by buyout-related CPR. Finally, 5.5s are less of a discount than 5s and so should not be as hurt by slower prepayments related to declining home price appreciation. Analysts do not favor 6s because of their expectations of increased production related to spill-over from the subprime market.
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