Even with the Ginnie Mae 5.5% coupon starting to move into the spotlight, analysts are hesitant to recommend an overweight in the sector yet. A sharp market sell-off could bring GNMA speeds to a near halt. This is why researchers from Goldman Sachs are suggesting investors hold conventional 5.5s rather than their Ginnie counterparts.

There are a number of indexed investors beginning to buy Ginnie 5.5s, as monthly issuance of more than $5 billion has made the coupon eligible for inclusion in mortgage indexes. Further, talk about the "scarcity value" of Ginnies has circulated, as it comprises merely 17% of the index.

However, researchers from Goldman said the current generation of investors has been shielded from the unique extension risk that only FHA/VAs have - assumability, which is considered the nemesis of Ginnies and could be easily triggered in the event of a substantial market sell-off.

Under the assumability option, a new homebuyer financed with an FHA/VA mortgage can choose to take over the payment schedule of the previous borrower. If interest rates rise to where the original mortgage is far below prevailing rates, this loan offers value to the new buyer.

For instance, a FHA/VA loan with a $120,000 balance is worth about $4,000, which would probably be divided between the buyer and seller, Goldman analysts said. The buyer might pay slightly more for the home, but would more than make up this cost in the form of a below-market mortgage rate. Since conventional mortgages do not permit assumability, housing turnover means a prepayment for the investor. But when a GNMA borrower moves, there would not be a prepayment if the loan were assumed. This may slow GNMA prepayments to a near standstill in a big rate backup.

The danger of assumability is more significant than it has been in a long time, wrote analysts, as home prices in certain markets have begun leveling off somewhat, or have even dipped. The surging housing market in the past decade served as an antidote to assumability. Rising home prices mean buyers will have to make up the difference between the mortgage and the home price. It also makes assumability a much less attractive option for borrowers, and provides GNMA vintages with a strong degree of protection against the problem of assumability.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

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