Street analysts said that recently announced changes to the GNMA II securitization program would give many lenders added flexibility in originating and securitizing Ginnie Mae loans, thereby enhancing issuance in the GNMA II sector.
These modifications in the program include changes in the minimum servicing fee in each pool to 19 basis points from 44 basis points (which could also be compared to 25 basis points for conventional pools) and modifications in the eligible note rates to 25 and 75 basis points over the pool coupon from the current 50 to 150 basis points. The changes also state that buydown loans can no longer be more than 10% of a multi-issuer pool.
Representatives from Ginnie Mae said that the changes would greatly benefit GNMA IIs without necessarily adversely affecting the GNMA I program.
"I think the changes will increase volume in GNMA IIs," said Ted Foster, vice president of MBS at Ginnie. "The expectation is that we have made the economics of originating GNMA IIs better for some lenders."
He added that there are lenders who have been wanting to take more income at origination as opposed to relying upon the long-term income from a servicing stream. These changes would help these lenders, thus making the program more appealing to them.
He also explained that the changes would not necessarily impact the GNMA I program. Foster said that the GNMA II is primarily for loans that are at odd mortgage rates, which have frequently been priced poorly to borrowers. "What we'd like to do is have those loans priced more consistently with the even coupon mortgages; if they do that, this would only be a net gain to the borrowers and not necessarily a loss of even coupons in the Ginnie I program," he said.
However, the Agency did not change the pay date on GNMA II pools to the 15th of the month, as was previously proposed. This was one part of the proposal that many market players found problematic.
"We were consistently told by the Bond Market Association and its members that their concern with the change of the payment date is the lack of fungability between existing GNMA IIs and the GNMAs IIs that would be created after July 1," said Foster. "Had we made the change, it could have potentially orphaned the old GNMA IIs and provided no liquidity on the GNMAs created after July 1."
Boost for GNMA sector
Street analysts said that these changes could foster issuance in GNMA IIs because it allows originators more flexibility. For instance, if existing market conditions continue, JPMorgan Securities analysts said that they expect low WAC GNMA II pools to be issued in July. The WACs would probably be lower than those for GNMA Is. This should provide an overall boost for the GNMA sector, they said.
"For the program to succeed, GNMA I/II swaps would need to narrow further," wrote the researchers. "The delay difference is worth about 2.5/32s. Currently, the GNMA I/II 5.5 swap is trading around 5+/32s."
Merrill Lynch analysts agreed that the changes would give originators much more flexibility in originating as well as securitizing GNMA loans. Specifically, they would have more of a chance to look at the prevailing coupon swaps in deciding whether to originate different coupons or whether to choose GNMA Is or GNMA IIs. They think that eventually GNMA IIs will become more popular due to servicers being more reluctant to hold excess servicing.
Other analysts said that what would really drive the GNMA II program going forward is the reduction in base servicing from 44 to 19 basis points.
"Originators have been selling servicing as IO essentially," said one MBS analyst. "Servicing is certainly not a bad asset, but originators have been lightening up on it." Further, because of the current size of the portfolios and technological advances that have been made, it does not really cost 44 basis points to service government loans, so maintaining base servicing at this level does not make economic sense.
He added that over the longer haul, the changes could make GNMA IIs the flagship program. This is because it would be much more flexible now to price for GNMA IIs, which would subsequently improve liquidity in the sector. "Ideally there won't be a concession going from GNMA Is to GNMA IIs, and over the longer term, this would help pricing in the FHA/VA market," he said.
Merrill analysts also pointed out that in terms of pricing, if GNMA IIs start being produced at lower WACs, they would eventually be worth more. This would mean that over time, GNMA I/GNMA II price spreads could lessen. However, older GNMA IIs are still deliverable into TBAs, and this would hinder an instantaneous shift in prices. This would particularly apply to higher coupons in which most of the outstanding securities will be the older, higher WAC securities. This would mean that any price movement in the GNMA I/GNMA II swap should be in current coupon, at least in the beginning.
In a recent Countrywide Securities report, analysts said that the changes to the GNMA II program should stop the erosion in GNMA II production that has occurred in the last few months. They said that GNMA II issuance has dipped significantly relative to GNMA Is. They explained that the most probable candidate for the diversion of FHA/VA production would be the Federal Home Loan Bank's MPF program, although no hard numbers are available.
Countrywide analysts added that since the payment date on GNMA II pools was not changed, this should cause GNMA I/GNMA II swaps to continue to collapse. Consequently, this would mean that GNMA IIs will remain an increasingly attractive execution option for originators, especially for liquid coupons such as 6s and 6.5s.
They predict that within a year of the effective date of the proposal, GNMA II production will routinely exceed GNMA Is. They added that it will be an interesting counter-development to see the response of the FHLBs to the modifications in terms of both their levels as well as their pricing methodologies.
Analysts from Merrill concur. "From a supply perspective, we could see slightly more GNMA production due to greater popularity of the GNMA II," they wrote. They added that they could see some shift from GNMA IIs to GNMA Is if servicers prefer to hold less excess servicing.
