By the Numbers
Up-in-coupon and into Ginnie Mae
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Agency MBS have posted negative excess returns for much of the year thanks to lower actual and expected demand from the Federal Reserve and banks. The Fed stopped adding MBS to its portfolio in March and will stop reinvesting most paydowns in June. Bank deposit growth is also likely to slow and reduce demand for agency MBS, and banks are likely shifting MBS purchases into Ginnie Mae rather than conventional. This has likely helped Ginnie Mae MBS outperform conventional MBS and suggests Ginnie Mae outperformance may continue. Returns improved in higher coupons with less exposure to MBS spreads and even turned positive for 4.5%s and 5%s.
Excess returns for most conventional coupons came in negative in April (Exhibit 1). However, returns improved steadily at higher coupons and the 4.5% and 5.0% coupons outperformed their hedges. Nominal spreads to Treasury debt increased 15 bp, so higher coupon MBS with lower spread duration fared better. The MBS current coupon increased 66 bp in April, which caused demand to jump for 4.5%- and 5.0%-coupon MBS that are not yet being produced by originators.
Exhibit 1. Conventional MBS excess returns (%)
Note: Excess returns reported by the Bloomberg Barclays MBS Index. Excess returns do not reflect any special dollar roll financing.
Source: Bloomberg, Amherst Pierpont Securities
Ginnie Mae excess returns also came in negative for most coupons in April (Exhibit 2). However, all but the 2.0% coupon outperformed the same conventional MBS coupon. Excess returns on 4.0%s were only slightly negative and turned positive for 4.5%s and 5.0%s. A few factors likely contributed to better Ginnie Mae returns. Ginnie MBS typically have shorter spread durations than conventional MBS and took less damage from spread widening this month. And bank demand for Ginnie Mae MBS may be increasing. Banks have suffered suffered large unrealized losses this year and can repair capital ratios by holding 0% risk-weighted assets like Ginnie Mae MBS instead of 20% risk-weighted conventional MBS or other assets with even higher risk weights.
Exhibit 2. Ginnie Mae MBS excess returns (%)
Note: Excess returns reported by the Bloomberg Barclays MBS Index. Excess returns do not reflect any special dollar roll financing.
Source: Bloomberg, Amherst Pierpont Securities
Conventional and Ginnie Mae excess returns have been similar for 3.0% and lower coupons throughout 2022 (Exhibit 3). But Ginnie Mae 3.5%s have outperformed hedges for most of the year, while conventional 3.5%s trended worse each month. Excess returns on conventional 4.0%s turned negative in mid-February but stayed positive for Ginnie Mae. Both sectors have outperformed hedges in 4.5%s throughout the year, but since mid-February Ginnie returns have exceeded conventional returns.
Exhibit 3. Conventional MBS excess returns have favored higher coupons
Excess returns reported by the Bloomberg Barclays MBS index. Excess returns are cumulative starting January 1.
Source: Bloomberg, Amherst Pierpont Securities
The OAS difference between Ginnie Mae and conventional MBS in 3.5% and higher coupons has converged throughout the year (Exhibit 4). For most of the pandemic investors have been concerned about high delinquency rates in Ginnie Mae MBS, which can lead to fast prepayment speeds and hurt investors in securities priced at a premium to par. However, most Ginnie MBS is priced below par and now would benefit from faster prepayments. Bank demand shifting from conventional to Ginnie Mae MBS may also be contributing to the narrowing OAS difference.
Exhibit 4. A narrowing between conventional and Ginnie Mae MBS OASs
Note: OASs from Bloomberg’s BAM prepayment model.
Source: Bloomberg, Amherst Pierpont Securities
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