MBS analysts are trying to figure out whether GNMA discounts will continue to pay down faster than their conventional counterparts.
JPMorgan Securities expects that speeds will be even between 2003 GNMA and FNMA 5s this year, but with a marginal bias towards GNMA speeds. "The latter are biased upwards due to a combination of high delinquencies, high mortgage insurance costs and the new GNMA hybrid ARM program," JPMorgan analysts said. They mentioned that in 2000, GNMA discounts were roughly in line to slightly faster when compared to conventionals, which is in direct contrast to what happened in 1994.
For the May prepayment report (reflecting activity in April), 2003 GNMA 4.5s prepaid at 9.3 CPR versus 6.1 CPR on FNMAs. Meanwhile, 2003 GNMA 5s prepaid at 16.3 CPR, compared with 16.1 CPR on FNMAs. "This may seem to suggest more robust speeds on GNMA discounts than FNMAs going forward - but that's an illusion," said researchers from UBS.
Discount speeds during or just after a major bout of refinancing activity offer minimal or no information on longer-term discount speeds in rising rate environments "The fact that GNMAs are prepaying faster right now is irrelevant because there a lot of things going on at the tail-end of this refinancing wave - such as cash-outs, for example - that have nothing to do with or how GNMAs are going to be prepaying six months from now," said Glenn Boyd, an analyst at UBS. Recent speeds on 4.5s to 5s are boosted by both cash-out and fixed-to-ARM refis. If rates stay elevated, both of those phenomena should lessen in the next few months, Boyd said.
GNMA speeds might also be temporarily elevated due to a change in originator focus. During refinancing waves, originators tend to focus on streamlined, easy-to-process loans as well as higher-loan balance borrowers, as opposed to GNMA mortgages. This happened when rates dipped down in mid-March. As a result, GNMAs tend to prepay faster as the originators refocus on them as rates rise again.
According to UBS, historical experience implies that, once discount speeds begin to actually reflect home sales (turnover), discount GNMAs should prepay more slowly compared to FNMAs. Borrowers in this sector are usually first-time homeowners with very little cash. Because of this, it takes more time for equity to build up. This is why historically GNMAs have displayed slower seasoning ramps in high-rate environments. Boyd said that since the market is transitioning into a higher-rate environment, there is reason to believe that GNMAs will likely display a slower seasoning ramp.
More on the seasoning
of GNMA discounts
Citigroup Global Markets believes that delinquencies will probably decline as the economy improves and unemployment drops. This could also reduce the quickness of GNMA seasoning. However, it is unlikely that this will counteract the effect of the significant dip in GNMA market share and the corresponding rise in delinquencies/buyouts. It is also unlikely that the long-term trend of lower Ginnie market share will reverse since the GSEs are under pressure to increase their affordable housing lending.
Citi also said that GNMA discounts have historically seasoned more slowly compared to their conventional counterparts because of a couple of factors. The first is high FHA/VA LTVs. LTVs that usually fall in the 90% to 100% range are a considerable hindrance to homeowners who might want to trade up to a more expensive house.
Another factor is the assumption of FHA/VA loans, which is the ability to transfer a below-market-rate loan from an existing homeowner to a new purchaser of the house. Often FHA/VA loans will be assumed if they are deep discounts and if the loan sizes are reasonable. In the last several years, home appreciation has been so strong that loan sizes have often been too small for the new buyer. This is why there have not been a lot of assumptions. But if the housing market were to weaken, there could be more assumptions
of discounts loans, which slows down speeds since the loan does not get prepaid.
Though speeds of 1993-originated GNMA 6s were faster than those of conventional 6s after the vintage became fully seasoned in 1999 to 2000, new GNMA product had slower seasoning in the higher-rate 1999-2000 time frame, Citi said. "Strong home price appreciation has likely reduced the impact of both high FHA/VA LTVs and assumptions of FHA/VA loans, and this might explain why seasoned GNMA discount speeds were faster than conventionals in 1999 to 2000."
Aside from this situation, FHA/VA has lost market share to rivals Freddie Mac and Fannie Mae. Therefore, it is probable that the credit profile of the average FHA/VA borrower has declined and moved closer to subprime collateral.
"The decline in GNMA market share suggests that the credit quality of the typical FHA/VA borrower has changed over time - that is, borrowers with better credit have migrated to conventional programs," said Robert Young, an analyst at Citigroup. Because of this, the FHA/VA pools could consist of lower-credit borrowers, manifesting through delinquency rates, which have increased in the last several years while the GNMA share has gone down. In terms of prepayment speeds, increased delinquencies should boost speeds on discount mortgages.
If home prices were to weaken, this would probably increase the frequency of assumptions and limit the ability of FHA/VA borrowers to trade up, Citi said. But in this instance, Citi predicts that the associated increase in delinquencies serves to counteract this effect, especially during the first couple of years of seasoning.
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