GNMA technicals are expected to be favorable over the near term. In recent research, JPMorgan Securities analysts noted that CMO demand is taking out around 60% of the issuance, while overseas and domestic bank demand has been strong.
They added that money managers should also be a steady buyer as GNMA index weights are now rising. This was partly caused by the increased issuance over the past year as the GSEs dealt with capital issues and tighter underwriting. The rise is also related to the delinquency buyouts, which has caused negative conventional net issuance.
Analysts estimated that as a result of the delinquency buyouts, GNMA index weights should increase at around 30 basis points per month over the next three to four months.
Based on an assumption that 20% to 25% of the mortgage universe is indexed, they calculated net demand potential from money managers for GNMAs at $3 billion per month.
Supply should also be limited by the tightening on Federal Housing Administration (FHA)-to-FHA streamline refinancings, while FHA Reform legislation if passed, would increase insurance premiums, thus dampening supply as well.
JPMorgan's report also highlighted the fundamental attractiveness in GNMAs related to declines in prepayment speeds with convergence to conventionals. Specifically, they noted the low prepayment convexity as the tightening in FHA-to-FHA refinancings has reduced voluntary prepays. Further inhibiting voluntary speeds are the ongoing poor state of housing valuations and tight lending standards — both of which aren"t expected to change anytime soon.
Analysts also stated that delinquencies and involuntary prepayments would remain a significant component of overall speeds, which provides extension protection in discounts. Even the better credit 2009 vintages could see 8% to 9% cumulative defaults in a year's time, assuming they continue to track the 2006 vintage experience, analysts said. They calculated this could translate into a 5% to 6% increase in CPR over the next year or so in baseline default speeds, which would "be invaluable extension protection."
In premiums, analysts expect default increases will be offset by lower voluntary prepayment speeds, thus providing call protection in higher coupons.
JPMorgan analysts currently favors an overweight to GNMAs across the coupon stack — 4.5s through 6.5s. Analysts also like GNMA PACs over 15-year MBS.
