After the Department of Housing and Urban Development recently allowed the Federal Housing Administration to insure 5/1 hybrid ARM loans with a 2% initial and periodic cap and a 6% lifetime cap (see ASR 4/4/05), Ginnie Mae followed up with an announcement that issuers will now be able to securitize this new product effective May 1. However, the Department of Veterans Affairs has not yet announced a similar program as of yet.
In recent commentary, Merrill Lynch noted that the current GNMA 5/1 program with 1/1/5 cap, along with the Agency's 3/1 program, have been ongoing since fall 2003. However, gross issuance in the 5/1 program has averaged under $20 million over the last six months, with a $100 million total outstanding balance. Merrill analysts said that a reason for the relatively low issuance volume is "the capital market's lack of enthusiasm in buying loans with 1% cap five-years out." This is where the forward curve indicates the cap will probably be in the money, thus reducing the interest to the investor. "A 2% initial cap could spark more interest from the markets, making it easier for lenders to offer these loans to borrowers as they can always package and sell them to investors," Merrill analysts wrote.
Ted Foster, vice president of MBS at Ginnie Mae, echoed this sentiment. "We were concerned from the beginning about the adjustment parameters of the 5/1 hybrid, which were just too narrow," he stated, adding that lenders and investors will benefit from the 5/1 cap change. With the 2/2/6 cap, he expects issuance in GNMA 5/1s would become much more in line with the agency's 3/1 hybrid ARM program.
By contrast, the Merrill Lynch report stated that gross issuance in GNMA 3/1s over the past six months has averaged roughly $700 million while carrying a current $11.5 billion outstanding balance. Furthermore, analysts noted that while net issuance in Ginnie Mae ARMS as well as fixed-rates has been negative over the last 12 months, GNMA 3/1s have grown in outstanding balance, thus increasing their share of the agency's MBS. "With the introduction of the new GNMA 5/1, we expect this trend (hybrid growth at the expense of 1/1 ARMs and fixed-rates) to continue, though within the hybrid sector, the GNMA 5/1s may also grow at the expense of the 3/1s, as some borrowers may select this new product choice," Merrill analysts stated.
Ginnie's Foster added that as rates rise, he expects more borrowers to move into ARMs, citing statistics that ARMs comprised only 5% of Ginnie Mae volume in August 2003, then rose dramatically to 20% in December 2004. In terms of hybrid ARMs, the sector comprised a little less than 9% of overall single family volume for the month, which is considered significant.
In terms of the effect on Ginnie Mae prepayments, Deutsche Bank Securities analysts previously reported that changes in the cap would probably not slow down or significantly speed up Ginnie Mae prepayments, especially considering the low issuance in the Ginnie Mae ARM sector. Other analysts, meanwhile, said that the effect on Ginnie prepayments should be minimal because higher rates have reduced the spread between primary fixed and ARM rates. This has, to a certain extent, minimized the appeal of ARMs as a vehicle for refinancing out of a fixed-rate mortgage, although they remain popular for home purchases. Success in the GNMA 5/1 product could reduce Ginnie Mae fixed-rate supply.
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