GNMAs have been outperforming conventional counterparts lately, reflecting the sector's favorable convexity profile and technicals.
Morgan Stanley researchers report that the GNMA positive convexity profile versus conventionals could be seen in the flatter refinancing curves.
This, in turn, has caused many buysiders to put extension risk on the back burner for these securities. Faster speeds in the discount coupons are a reflection of home price appreciation as well as the higher effective coupon paid by Ginnie Mae borrowers due to the Mortgage Insurance Premium. A GNMA borrower could therefore refinance into a conventional mortgage as soon as adequate home equity is accumulated and escape the additional 50 basis point insurance premium.
However, analysts said that GNMA convexity only partly explains the outperformance of the GNMA to FNMA swap, and that it could also be explained by technical factors.
Alec Crawford, managing director and head of agency MBS strategy at RBS Greenwich Capital, said that GNMA outperformance is caused by the limited supply in the sector on one hand and robust demand on the other. Crawford said that a number of their clients, including GNMA funds and certain non-domestic investors, could only purchase GNMAs. He added that current sector valuations will hold unless significant additional GNMA supply enters the market. There are two situations that could trigger this to happen, Crawford said. One possibility is a large GNMA holder could sell; the other being that origination in the sector increases. However, anecdotal evidence from originators indicates that issuance would not be increasing even with the lower rates available to Federal Housing Administration borrowers versus conventional homeowners. And though there has been modest GNMA selling over the past week, it was not enough "to take GNMAs to where they were a month ago," Crawford said.
RBS Greenwich is currently neutral weighted on GNMAs. "It's a very technical situation," said Crawford, adding that very few people out there really have full information on what is really happening in the sector. Exacerbating the situation is, again, the lack of supply. For instance, 30-year GNMA Is currently only make up 8% of the liquid agency market. "Taking a big position whether long or short is pretty risky at this point," Crawford noted.
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