MBS market players have found value in certain sectors of Ginnie Mae MBS as rates continue falling.

Art Frank, director of mortgage research at Nomura Securities International Inc., said that he prefers lower coupon GNMAs, particularly 6s and 6.5s. He also likes 5.5s, although these are pretty thinly traded.

"On fundamentals we like lower coupon Ginnies compared to Fannies," he said. "Ginnies do not have significantly more extension risk than Fannies They have some call protection compared to Fannies and, at this point, you are not paying up at all to get the full faith and credit guarantee, which is also worth something ."

However, Frank said that higher coupon Ginnies look pretty fully priced and he expects more compression in the 6s to 8s coupon stack. Also, he said Ginnie 6s and Ginnie 6.5s are more attractive only if you are not a dollar roll investor.

"Fannies and Freddies tend to roll a little better if you roll every month," Frank said. "But for non-roll accounts, Ginnie 6s are an attractive coupon, and to a lesser extent so are Ginnie 6.5s."

Value in premium GNMAs

One sector in which analysts have found value is in premium Ginnie Maes. Over the last year, this sector (both Ginnie Is and IIs) experienced slower prepayments than their conventional counterparts, despite some convergence in the last few months.

Also, even though GNMA premium speeds were slightly faster than conventionals in June, they have generally been more moderate over time. Analysts said that the differences were especially marked in late 2001, when conventional speeds were very fast.

Though experts have acknowledged that GNMA speeds are notoriously difficult to understand - given that the sector is subject to servicer buyouts due to delinquencies - GNMAs are still expected to perform incrementally better than their conventional counterparts. Analysts said that any spike in conventional speeds is still expected to be much greater than that experienced by at- and in-the-money GNMAs. This is why the low mortgage rate environment will cause prepayments for cusp and premium Ginnie speeds to lag conventionals.

In regards to the relative value in GNMA Is and GNMA IIs, analysts noted that premium GNMA Is have traditionally shown superior prepayment performance versus GNMA IIs. However, because of their relatively small pool size, GNMA Is are more vulnerable to delinquency-related buyouts. Investors can reduce this risk by buying GNMA IIs, which are usually bigger pools, or by creating larger or more diverse pools with different groups of issuers.

GNMA speeds will go back to normal

Though GNMA speeds were generally more aggressive in the July report, as mentioned above, they are expected to go back to historical norms versus their conventional counterparts.

According to UBS Warburg, with rates reaching their historic lows, originators are currently not focusing solely on FHA/VA refinancings. The more likely occurrence would be FHA/VA borrowers exhibiting lower application fallout (when original refinancing is delayed and a new application is made at a later date), because these borrowers are sometimes cash-constrained (making it difficult to pay a new application fee) or don't have borrower sophistication (FHA/VA borrowers are usually first-time homeowners). The lack of application fallout will cause GNMA refi-responsiveness to go back to historical norms versus conventionals.

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