Last week Ginnie Mae announced changes to its buyout program in a move that Street observers say will dampen the prepayment volatility of the sector, a clear positive for GNMAs issued at the beginning of 2003.
The agency said last Tuesday that for mortgages placed in pools issued beginning Jan 1, servicers will only be allowed to repurchase delinquent loans if they have missed three consecutive payments. This differs from current criteria, that allows issuers to buy out loans that have missed just a single payment if it has remained uncured for four consecutive months. The new rule is not retroactive so the less restrictive buyout rules are in effect for pools issued before 2003.
Some Street analysts speculated that this move was done to appease investors who object to how fast GNMA speeds have been recently. GNMAs have been prepaying faster than their conventional counterparts. This has become more of an issue for GNMA Is where some small pools often prepay at 90 to 100 CPR, according to experts.
Representatives from Ginnie Mae said that the changes were meant to help homeowners rather than slow down GNMA prepayment speeds. "The diminished speeds will be the effect we anticipate, but it is not the fundamental reason why we did it," said Ted Foster, vice-president of MBS at Ginnie.
"We've been contemplating this for awhile and as we saw more and more of an industry springing up around reperforming FHA/VA loans, it became clear that what was going on was not meeting our original intent, which was to help loss mitigation," he added.
Rather than loss mitigation being the central theme, "there was a whole industry based exclusively on the economics of when to buy the loan out that had nothing to do with the homeowner. The original policy was to help out the homeowner - to give servicers some latitude in dealing with homeowners, and it just wasn't turning out that way," he stated.
Foster further explained that GNMA didn't make the changes retroactive in order to protect
the value of the assets that have already been booked by issuers and servicers. He said that the agency wanted to balance the interests of the investor and the servicer. Researchers said that typically changes like these affect the servicing agreements on outstanding pools. On the other hand, the changes had to be made because buyouts are considered detrimental by Ginnie premium investors. Making the new policy non-retroactive is a good compromise.
Effect of the changes
According to MBS analysts, these changes will not choke off the supply of FHA/VA reperforming loans over the next couple of years.
"The change only applies to pools issued on or after Jan. 1, 2003," said Art Frank, head of mortgage research at Nomura Securities. He explained that most seriously delinquent loans bought out of pools are seasoned by at least a couple of years. Since 2002 and earlier loans are still grandfathered under the old rules, it should not seriously reduce the supply of FHA/VA reperforming loans over the next two years.
"In terms of the effect on GNMAs, our thought is that 2003 production GNMAs would be worth more than 2002 production because they have better call protection with these more restricted buyout rules," stated Frank.
He added this is clearly true for premiums and to a lesser extent for current coupons.
Frank also noted that the cheapest-to-deliver in a TBA trade for Ginnies in 2003 ought to be 2001 or 2002 production. 2003 production should be trading higher than the TBA price because of better call protection.
David Montano, head of mortgage research at JPMorgan, wrote that they expect that the changes will specifically benefit GNMA 6s and GNMA II 5.5s, which are the current production. He added that higher coupon GNMAs may have their rolls under pressure in the near-term and would strengthen in January as investors attempt to strip out the new production.
In a report by Salomon Smith Barney, analysts said considering the level of reperforming GNMA collateral deals issued over the
past year, buyouts are probably accounting for approximately
3 CPR to Ginnie speeds. Researchers said that because the restriction does away with the provision judged as the major contributor to the opportunistic buyout activity of recent years, the new rule would probably reduce speeds by a few CPR for pools issued in 2003 and after. The reduction would likely be even greater for collateral "that eventually becomes moderately seasoned, more in-the-money, or issued by lenders active in the reperforming market," wrote Salomon analysts.