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As primary rates go, so goes relative value

admin | April 23, 2021

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.

With MBS spreads near the tightest levels in market history, small differences across sectors have a bigger impact on relative value. One set of differences includes effective primary market rates. Conventional conforming loans and FHA and VA loans all get different rates. So do nonconforming jumbo loans. Lately, VA rates have run noticeably low, and nonconforming jumbo rates noticeably high. All else equal, relative value lines up the same way.

The average rate received by a mortgage borrower has fallen almost every month since the start of 2019 (Exhibit 1). This is reflected in the average rate on conforming balance loans sold into Fannie Mae, Freddie Mac, and Ginnie Mae pools and grouped by the month of origination. This approach is more accurate than rate surveys, and the major surveys do not include data on VA loans. The disadvantage in origination data is delay, since there are lags between rate lock, closing, and pooling. The market can only track data on loans originated through March, and those data do not yet reflect the full impact of higher rates in February and March 2021.

Exhibit 1: Mortgage rates have fallen steadily since the start of 2019

Note: Conforming balance loans only. GSE loans include only owner-occupied loans. Data on loans originated through March 2021.
Source: Fannie Mae, Freddie Mac, Ginnie Mae, Amherst Pierpont Securities

VA borrowers typically receive a much lower rate than conventional borrowers (Exhibit 2). This is mostly due to the guarantee fee difference between Ginnie Mae and the GSEs. Ginnie Mae does not buy the credit risk of loans sold into pools. They expect all servicers to remit the required principal and interest each month for loans in Ginnie Mae MBS, even for loans that have stopped paying. A servicer that fails to do so is in default, and only then would Ginnie Mae need to advance the missing principal and interest to the MBS. Since all Ginnie Mae loans are insured or guaranteed by another government entity, the Ginnie Mae guarantee fee is very small. The GSEs, which do bear the direct risk of borrower default, need to charge a much higher amount. On average the guarantee fee difference can exceed 50 bp, and much of that difference is captured by VA borrowers.

Exhibit 2: VA borrowers typically receive much lower rates than conventional borrowers

Source: Fannie Mae, Freddie Mac, Ginnie Mae, Amherst Pierpont Securities

FHA rates are typically higher than VA rates, even though they can be sold into the same MBS security. Lenders often place credit overlays on FHA borrowers, reflecting higher FHA default rates; lenders face some costs when loans default. Both FHA and VA rates increased relative to conventional rates after 2017 and the spread between FHA and conventional mortgages was typically within ±10 bp.

Spreads on FHA and VA loans compared to conventional loans have widened since late 2020. This means government rates were falling faster than conventional rates at the end of the year and may indicate that government rates have not increased as much as conventional rates over the last few months. As a result, Ginnie Mae speeds may not fall as much as conventional speeds. Data from the MBS’s weekly applications survey backs this up. The survey shows the conventional refinance index has fallen more than the government refinance index since January, and that FHA rates have been lower than conventional rates for most of 2021.

A similar trend can be seen in agency-eligible and agency-ineligible jumbo loans (Exhibit 3). Rates for these loans usually are calculated relative to conforming balance conventional loans. The spread for conforming jumbo loans is typically close to zero, while FHA and especially VA jumbo loans still receive lower rates. Spreads for FHA and VA jumbo loans widened to the conventional benchmark similarly to their conforming balance loans.

Exhibit 3: FHA, VA, and non-conforming jumbo spreads are also falling

Source: Fannie Mae, Freddie Mac, Ginnie Mae, Bankrate, Amherst Pierpont Securities

Bankrate estimates the rate for jumbo loans that are too large for agency MBS. Typically, these loans received higher rates than agency-eligible loans, although from mid-2017 through mid-2019 the jumbo rate fell below the average conforming rate. This coincided with a big increase in private-label securitizations. However, PLS issuance dried up during the early months of the Covid-19 pandemic, sending spreads higher. Spreads appear to have fallen in the second half of 2020 and into 2021, which suggests that jumbo rates may not have increased as much as conventional rates in 2021.

The most watched indicators of 30-year mortgage rates track conventional mortgages. However, rates for alternate products like FHA, VA, and jumbo loans do not always move in unison with conventional rate. Unfortunately, it can be difficult to get a real-time view of the prevailing mortgage rate for some products, like VA loans. Reviewing origination data can provide insight, albeit lagged, into recent origination trends and shows that originators may be putting more focus on FHA, VA, and jumbo loans.

Investors should keep differences in primary rates in mind. For the same MBS coupon and same collateral WAC, securities backed by VA loans may have a higher refinancing incentive than other collateral. FHA and conventional conforming loans may have an incentive somewhere in the middle. And jumbo nonconforming loans may have the lowest. In a market with tight spreads, the resulting differences in prepayment speeds and carry can add up to something that matters.

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