A recent Mortgage Bankers Association (MBA) study showed that the government-insured share of mortgage applications continues to increase compared with their conventional counterparts.

According to the MBA, among all the mortgage applications in October, 32.9% were for government-insured loans (comprising mainly Federal Housing Administration (FHA) loans), compared with 10.3% in October 2007.

Indeed, the market for FHA loans has grown, which in turn has boosted volume in Ginnie Mae (GNMA) securities.

"This was the only portion of the MBS market that was not 'broken,'" said Bill Chepolis, a managing director at DWS Investments. He added that there is still a serious lack of liquidity in the jumbo sector as a result of limited balance sheets and investor interest. "Investors were not willing to purchase Freddie Mac (FHLMC) and/or Fannie Mae (FNMA) due to the uncertainty around their financial health and how the U.S. government would be dealing with them," he said.

The increase in FHA conforming loan limits certainly helped. "GNMA took the lead in how they were going to deal with these larger allowed loans," Chepolis said. "I think the keys to growth going forward will be housing values - you can't refinance if your house is worth less than your mortgage - and employment."

Numbers Tell the Story

The dramatic increase in FHA issuance can be seen in the numbers. According to an MBS analyst, in 2008, FHA endorsements are projected to reach more than $176.1 billion. This compares with $79.5 billion for all of 2007 and $53.7 billion for 2006.

"A major change that has affected FHA production is the fact that the private-label market mortgages basically shut down in 2008," the MBS analyst said. "As a result, FHA has played a different role as the only lender out there for people with lower FICO scores who need to take out high-LTV loans." Specifically, these are borrowers with LTVs over 90 and FICO scores below 660, although the MBS analyst said that those with LTVs from 85 to 90 might also fall under this category depending on what their FICO score is.

The increase in FHA-originated loans was driven by, among other factors, the collapse of the non-agency market, according to Nicholas Strand, an analyst at Barclays Capital. "What you saw toward the end of 2007 was a rise in government mortgage loan applications from the migration of non-agency borrowers to the FHA program," he said.

In a report released earlier in 2008 called Ginnie Mae: The Forgotten GSE, Strand wrote about how in the beginning of 2007 GNMA issuance, which comprises roughly 80% FHA collateral, was around $5 billion per month - in line with averages over the previous two years. But, starting around August 2007, issuance has picked up steadily.

Strand said that one of the factors driving this surge in the FHA program is its fee structure.

Both FHA and FNMA/FHLMC have upfront fees and running mortgage insurance fees, although the latter fee applies only to borrowers that have 80+ LTV for FNMA/FHLMC loans. The difference here is that there are upfront delivery fees for FNMA/FHLMC, while FHA has upfront mortgage insurance premiums. However, despite the fees being charged in both cases, the FHA channel continues to have lower total fees for higher-LTV/low-FICO borrowers.

Strand said that for borrowers with lower FICO scores and higher LTVs, the FHA route provides better execution in terms of the rates they have to pay on their mortgages, including the upfront fees and running mortgage insurance premiums. "The FHA channel is generally more affordable for most high-LTV/low-FICO borrowers," Strand said. "For agency execution, a borrower with less than a 620 FICO score could have an upfront delivery fee of close to three points; in addition, high-LTV borrowers could have running mortgage insurance fees of up to a one and half percent."

The MBS analyst said that despite the fact that PMI premiums have gone up for those with FICO scores above 660, these are still lower than premiums for subprime with teaser rate ARMs.

"Until the private-label market reopens for these borrowers, which seems years away, FHA is going to be the only option for lower-credit borrowers," the MBS analyst said.

Higher GNMA supply is reflected in the sector's performance, and could be seen in the lag in GNMA/FNMA swaps. Sources said that it seems there is a disconnect in the market between full-faith-and-credit MBS and bullet bonds (i.e., Treasurys versus agency debentures). This might be the result of the increased supply of GNMAs or prepayment expectations.

At last Tuesday's 3 p.m. close, the GNMA/FNMA 5% swap was at negative one tick, according the MBS analyst. In other words, GNMA 5s were a tick cheaper than FNMA 5s. In fact, all actively traded GNMA/FNMA swaps - 5s through 6.5s - were negative at Tuesday's close for the first time this year. He attributed this largely to heavy GNMA origination.

Increase in Loan Limits

Last March, the Economic Stimulus Act of 2008 temporarily raised the FHA and conforming limits for most areas of the country, which made FHA financing open to more borrowers.

The passage of the Housing Bill in July, however, permanently increased the loan limit to a maximum of $625,000 in 2009. This is lower than the temporary limit of $729,750 for 2008.

"The increase in loan limits will have only a modest effect on overall issuance," Strand said. In a report entitled Ginnie Mae Jumbos: Much Ado About Nothing, Strand wrote that after filtering all loans based on size, FICO/LTV and documentation type, Barclays estimates that around $200 billion of outstanding mortgages are eligible for the GNMA conforming-jumbo program. At current rate levels however, Barclays projected only $10 to $15 billion to refinance into this program by the end of this year. Meanwhile, new purchases could add $5 to $10 billion of supply, which brings Barclays' total estimate for the program's supply to $15 to $25 billion by year end.

The MBS analyst added that increasing the loan limits for FHA loans has had a modest impact on GNMA jumbo issuance. He said that with the 2009 FHA loan limit coming down to $625,000, only 10% of the original balance of these loans will be TBA eligible, and only those originated after Oct. 1, 2009. Those originated in 2008, when the temporary limits were raised to $729,750, are not TBA eligible, the analyst said.

Other sources said the ceiling coming down to $625,000 in 2009 from $729,750 in 2008 will have an inevitable impact on the real estate markets in high-cost states. There already has been anecdotal evidence, a source said, of lenders no longer taking applications for jumbo conforming loans larger than $625,000.

Other than GNMA

Thus far the only financing channel for FHA collateral has been via GNMA securities. With the recent growth in FHA loans, the question becomes whether there will be alternative avenues for financing these loans, such as private-label ABS.

Experts said that considerations such as pricing will prevent FHA products from being funded through the private-label route.

"Several of the large issuers - Wells Fargo, Bank of America - have been posting rates in excess of 8% for jumbo loans over $1 million," said Chepolis of DWS Investments. "This is for 'good' borrowers."

This indicates that these issuers are not sure about their pricing models, according to Chepolis. "If they have to hold it on balance sheet, they want to be amply compensated, and if they are going to sell it into the market, they want to make sure they have plenty of room to hit a bid - which could be far away from that level," he said. He added that GNMA loans are currently being originated somewhere around 5.25% up to roughly $700,000.

There are some factors to consider in packaging new issue government-guaranteed loans as a private-label MBS.

"It would trade as a security at a better level, but the fact that it has a private label would cause it to trade wider than the underlying collateral," Chepolis said. "This would be like creating a CMO from Treasury collateral - you would be paying out more than you would receive."

He added that the underlying GNMA pools are more liquid compared with the subsequent structure. "You see this now in some older structures that were created with re-performing GNMA loans - loans that were delinquent, but then 'cured' and restructured into passthroughs," Chepolis said.

The GNMA Perspective

Joe Murin, the president of GNMA, said that the question is why FHA production "hadn't been there all along."

He cited the refinance wave that started in 2002 and the growth of subprime lending as factors that had virtually eliminated the government mortgage lending sector.

However, with the private-label market now gone, FHA loans have comprised roughly 40% to 55% of mortgage loan production for the bigger lenders this year, and even more than that for smaller to mid-size companies. "All of a sudden, FHA is the place to go," he said, "although government financing has been present through good and bad times."

One of the factors to have made FHA a more compelling option is the implementation of programs that have improved loan deliverability - for instance, the FHA's Lender Insurance Program (LI), which enables high-performing lenders to insure FHA forward mortgage loans without a pre-endorsement review by the Department of Housing and Urban Development (HUD).

The expedited procedure forms are part of HUD's efforts to make the processing of FHA-insured loans easier for lenders as well as more cost-efficient for potential homeowners.

Agency Growth

As a result of the surge in FHA production, GNMA has been securitizing in the range of $27 to $30 billion in the last few months, as compared with an average of $7 billion during the height of subprime lending. In fact, in November and October, the agency securitized more than FNMA and FHLMC, coming to market with $27.1 billion in November and $29 billion in October. Government funding, Murin said, has become a very "relevant component of liquidity in the current market."

Murin added that when things normalize once again, the rule of thumb should be that government financing must make up 25% to 30% of the mortgage business.

"It's a good balance for mortgage lenders, and it will be a good source of diversification for them," he said. The increase in FHA loan limits also allows a different class of borrower to enter the FHA program, which provides lenders with more diversification, Murin said.

(c) 2008 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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