By the Numbers
An opportune time for an FHA MIP cut
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. This material does not constitute research.
Investors in Ginnie Mae MBS have long worried about another reduction in FHA mortgage insurance premiums or MIPs, which typically would drive a pickup in refinancing and hurt the value of MBS trading above par. This has been a significant concern since most of the market traded at a premium for the last two years. However, nearly all Ginnie Mae MBS now trade at a discount to par and the effect of dropping insurance premiums is much lower. But any new loans originated at today’s higher rates will carry substantial exposure to a premium reduction. If the FHA intends to lower premiums, now may be the best time for investors to accept the change.
The G2SF 2% TBA priced at $100-10+ on January 3, putting more than 99.5% of Ginnie Mae MBS above par. A cut in FHA insurance premiums would have increased refinance incentives and eroded the market value of these securities. For example, a 30 bp MIP cut would likely have erased roughly $3.0 billion market value of Ginnie Mae MBS (Exhibit 1). But lower MBS prices have pushed 96% of MBS below par and dropped the effect of a 30 bp MIP cut to $449 million.
Exhibit 1. Higher interest rates have muted the effect of a MIP cut
Note: The estimated change in market value and other security attributeds is for a 30 bp cut in MIPs.
Source: Yield Book, Amherst Pierpont Securities
The large 2.0% and 2.5% coupons now benefit from a MIP cut, since it could provide a marginal boost to turnover speeds. The 3.0%, 3.5%, and 4.0% coupons still lose some value since the OAS model assigns some probability that rates could fall and refinancing increase. But the value lost is much less than at the start of the year. A MIP cut lowers convexity, but for most coupons the drop is much less than at the start of the year.
It is important to note that a MIP cut is not guaranteed. The FHA is still assessing the outcomes of loans exiting Covid forbearance. And uncertainty around inflation and the economy might encourage the FHA to wait longer to assess the health of the insurance fund. On the other hand, strong home price appreciation has continued into 2022 and makes it easier to accommodate lower premiums.
If the FHA chooses to lower premiums, the amount is likely to be less than by 30 bp. A 30 bp cut would bring premiums back to the level preceding the 2008 financial crisis. But the fund went negative in the years following the crisis, providing real world experience that a 55 bp premium is insufficient to keep the fund solvent.
The other benefit of cutting premiums sooner rather than later is that newly issued pools will have greater exposure to a cut than most currently outstanding pools. An investor would prefer to buy a 4.5% pool with a 70 bp MIP than an 85 bp MIP. If many 85 bp MIP pools are issued before premiums are cut then there would be a larger effect on Ginnie Mae II TBA prices, which would ultimately raise rates for Ginnie Mae borrowers. Lowering MIPs before those loans can be originated should protect the value of the par coupon TBA.
Exhibit 2. A MIP cut has a larger effect on higher coupon TBA prices
Assumes 30 bp MIP cut for TBA backed by 85 bp MIP loans.
Source: Yield Book, Amherst Pierpont Securities
Production so far in 2022 has still been primarily in 3.5% and lower coupon pools that are no longer too exposed to lower premiums. Even the April multi-issuer pools are still dominated by loans in 2.5%, 3.0%, and 3.5% pools. But production will shift higher in the coming months—the prevailing FHA rate was 5.21% as of April 28, according to Optimal Blue’s rate lock index.
Finally, a MIP cut is never a benefit to investors in interest-only securities, which only lose cash flow when prepayment speeds increase. However, it still may be better to deal with a cut now that reduces the exposure to MIPs in new issue IOs backed by 4% and higher coupon pools.
This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.
Important Disclaimers
Copyright © 2024 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.
In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.
The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.
This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.
In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.
Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.
