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Value in Ginnie Mae low loan balance pools
admin | September 28, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Like conventional borrowers, FHA and VA borrowers with smaller loans are less likely to refinance since potential savings are lower. But the only way to create Ginnie Mae specified pools is through the Ginnie Mae II custom program, and those pools are not TBA deliverable. This hurts execution and helps keep payups lower than theoretical levels, increasing the value to investors. Ginnie Mae low loan balance pools look like a good source of call protection for investors.
Low loan balance Ginnie Mae pools offer substantial call protection
Borrowers with smaller loan balances prepay more slowly since less money is saved by refinancing compared to a larger loan. There are also fixed costs in the origination process—home appraisal and credit reports, for example—that disproportionately reduce the savings for smaller loans. Exhibit 1 (below) shows that the S-Curves for 2016 and 2017 originated loans are progressively flatter as loan size decreases.
Exhibit 1: Ginnie Mae S-curves flatten as loan size decreases
Source: Ginnie Mae, eMBS, 1010data, Amherst Pierpont Securities
Another reason these loans prepay slower is loan officer compensation, which is proportional to the loan amount. However origination and underwriting requires the same amount of time and effort regardless of loan amount. Therefore loan officers have less incentive to solicit these borrowers to refinance. This means low loan balance pools provide prepayment protection for even traditionally fast servicers.
Low balance loans were less sensitive to the FHA’s MIP reduction
FHA prepayments are sensitive to the current level of annual mortgage insurance premiums (“MIP”) charged by the FHA. If the current loan is paying a higher MIP it could make sense to refinance even if the note rate is unchanged. While the current administration has signaled that MIP cuts are unlikely, this policy risk remains a concern for many investors.
Low balance loans proved less sensitive to the January 2015 MIP cut, which lowered the annual MIP to 85 bp. Prepayment speeds for the 2013 and 2014 vintage loans, which predominantly paid 135 bp MIP, are shown in Exhibit 2 (below). The MIP reduction and a drop in mortgage rates triggered a massive spike in prepayments—FHA 4.5%s with loan size greater than $200,000 topped 70 CPR. However, lower loan size buckets prepaid progressively slower, culminating in virtually unchanged speeds in the LLB cohorts.
Exhibit 2: Low loan balance protected against FHA MIP cuts
Source: Ginnie Mae, eMBS, 1010data, Amherst Pierpont Securities
Low loan balance protects against fast VA prepayments
Low balance loans have also provided call protection for VA loans, which have prepaid very quickly over the last few years. Exhibit 3 (below) shows S-Curves for 2016 and 2017 vintage VA loans, which have been some of the worst performers. The call protection afforded by loan balance is evident—high balance 2016 VA loans reached 90 CPR at the peak of the S-Curve while LLB loans remained at roughly 10 CPR.
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