The implementation of significant changes in the pooling requirements of the Ginnie Mae II program will begin on July 1. Specifically the new WAC ranges for Ginnie II securities will go into effect. The sector will be more attractive to both issuers and investors thanks to these changes, analysts said.
In a recent report, Countrywide Securities said that the most significant change in the Ginnie program would be to the pool servicing and gross WAC levels.
Countrywide explained that Ginnie pools can now contain loans with note rates that range from 50 to 150 basis points above the passthrough coupon. Beginning next month, loans in Ginnie II pools will have rates that only range from 25 to 75 basis points above the passthrough coupon. In addition, only 19 basis points of servicing will be required, which should cause gross WACs on the product to decline over time. "In a high financing environment, every basis point reduction of gross WAC can be valuable to investors," wrote CSC analysts.
The report said that the changes in pooling requirements "will be important to both issuers and investors." They added that many issuers have wanted this change for some time so that they could retain less servicing. Larger issuers have apparently decided that holding less servicing is advantageous for a number of reasons - one being that this change is viewed favorably by stock analysts.
In addition to the decline in gross WACs across Ginnie II coupons, there will be significantly less dispersion in underlying note rates of Ginnie pools. Countrywide said that for premium securities, a pool with note rates grouped closely around the gross WAC is more valuable compared with a pool with the same average WAC but greater note rate dispersion.
Market uncertainty
A wide WAC dispersion within a security creates both market uncertainty and a volatility issue, said Stephen Ledbetter, director of Securities, Policy and Research in the Office of Capital Markets at Ginnie Mae.
"When there is a wide range of underlying mortgages, there exists the potential for a wide range of prepayment behavior," said Ledbetter.
A loan with a note rate of 50 basis points above the passthrough coupon and a mortgage with note rate of 150 basis points above the passthrough coupon are very different loans, so the prepayment characteristics on those mortgages are very different as well. Investors have to take that into account in valuing that security. To the extent that buysiders have difficulty determining the prepayment characteristics of that security, they would treat it as if it were part of the TBA market - as a "cheapest-to-deliver" kind of valuation.
"By narrowing that dispersion, we obviously remove the uncertainty with respect to the prepayment characteristics of the underlying mortgages and so we would expect to get better pricing as a result," stated Ledbetter
Another significant change in Ginnie's program is its policy with regards to buydown loans. After July 1, any Ginnie II pool that has more than 10% in buydown loans should be denoted "BD."
"I would characterize this change as in the spirit of improving disclosures around our securities," said Ledbetter. He said that one issue that Ginnie Mae is trying to address is the investor's inability to know exactly what is in the security with respect to buydowns.
In the near term, Ledbetter said that the pricing of new Ginnie IIs is going to closely follow old GNMA IIs. However, over time, as the market understands Ginnie IIs better and as liquidity in the sector picks up, then investors will be able to evaluate the real impact of changes in the Ginnie II program and begin to reward new Ginnie IIs for the better security performance.
Ledbetter added that he expects prepayment characteristics of new Ginnie IIs to be different from old GNMA IIs, assuming the gross WAC in new Ginnie II 5.5% would be substantially lower than the gross WAC in the old GNMA II.
It is still not definite what the gross WACs on the securities will be exactly. But it is expected that the new Ginnie IIs will have lower WACs compared to old Ginnie IIs. Thus, prepayment characteristics of these securities would be different, because a higher coupon mortgage generally prepays faster in a given interest environment.
Ginnie's exceptional
performance
In a report released last Wednesday, UBS Warburg also said that Ginnie Maes have done exceptionally well relative to their conventional counterparts over the course of the previous week.
UBS gave three reasons why Ginnies have done relatively well. GNMA production is very limited. The agency's share has only been about 10% of total fixed rate production, which is lower than previous experience. Also, with prepayments set to accelerate in the coming months, Ginnies are probably going to accelerate less than their conventional counterparts. For one, the average Ginnie Mae borrower is less sophisticated and more cash-constrained than the average conventional homebuyer.
Further, UBS said that Ginnie's outperformance coincided with a sharp move to lower rates, as well as the general perception that Ginnies would likely speed up less than their conventional counterparts.
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