By the Numbers
Allocating Ginnie Mae exposure between MBS and CMBS
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.
Investors looking for Ginnie Mae exposure can choose between residential mortgages packaged in TBA pass-throughs or collateralized mortgage obligations (CMOs) or can choose commercial multifamily mortgages in Ginnie Mae project loan deals (GNPL). The deep liquidity of the residential TBA pass-throughs comes with significant negative convexity due to the prepayment risk. GNPL front sequentials also have prepayment risk, but that risk is tempered somewhat by lockout provisions, prepayment penalties and some buffering by the deal structure, which is particularly effective in the early years of the deal. Ginnie investors who went overweight single-family and underweight multifamily in 2022 should revisit that allocation in 2023, as project loan rates and deal spreads have finally caught up to the sell-off.
Throughout the latter half of 2022, Ginnie Mae project loan commitment rates lagged both rising Treasury rates and Ginnie Mae single-family current coupon rates (Exhibit 1). The lag between the closing of multifamily loans and deal issuance also meant that most dealspriced at a deep discount as rates rose through 2022. Ginnie Mae investors who wanted par coupon or higher coupon pass-throughs or sequentials often migrated to the residential mortgage market. Project loan commitment rates finally spiked higher late in the fourth quarter, and many new deals coming to market will be issued close to par or even at a premium, with weighted average coupons between 4.5% and 5.0%.
Exhibit 1: Ginnie Mae project loan versus single-family mortgage rates
Note: Project loan data through December 2022. Data revised as new deals enter the market.
Source: Ginnie Mae, Bloomberg, Amherst Pierpont
Deals printed in November still had gross weighted average coupons that barely hit 4.00%, with coupons on the front sequential A classes typically in the high 2.0%s to low 3.0%s (Exhibit 2). The par coupon Ginnie Mae TBA is currently about 5.00%, with the G2SF 5.0 priced at a slight premium. Some investors, particularly banks, tend to have accounting rules that make buying bonds at a significant premium or discount cumbersome, something that contributed last year to the migration to TBAs. Even when the yields are similar, the optics of a 3.25% GNPL coupon instead of a 5.00% TBA coupon when short term rates are 4.50% can be demoralizing for a portfolio manager.
Exhibit 2: Baseline comparison of recent GNPL deal and single-family TBA
Note: The static project loan analysis is done at 15 CPJ, or 15 CPR and 100 PLD, where 100 PLD is the standard project loan default (PLD) curve. Duration is the modified duration of the Ginnie Mae project loan at 15 CPJ, and the OAS effective duration of the TBA. Convexity is the OAS effective convexity. Data as of 1/6/2023.
Source: Bloomberg, Amherst Pierpont
That problem with static scenario analysis is that it’s, well, static. The projected performance of the GNPL front sequential compared to the G2SF 5.0 is shown in Exhibit 3 for various changes in CPR. Ginnie Mae project loans have been prepaying between 4 CPR and 9 CPR for the last six months, and the G2SF 5.0 TBA has a 3-month CPR of 8. The modified duration of the multifamily front sequential and the TBA shown is both around 5.5 to 6.0 at current speeds, with an average life of about six years.
Exhibit 3: Projected yield comparison
Note: Comparison shows the modified duration for both bonds, which is closer to the weighted average life of the mortgage for the TBA than the effective duration shown in Exhibit 2. The N-spread for both bonds is the static spread to the LIBOR swaps curve. Scenario analysis from Bloomberg as of 1/6/2022. Constant CPR.
Source: Bloomberg, Amherst Pierpont
At roughly current speeds, the projected yields of the two bonds are close to equal, as the yield graphs cross just above 7 CPR. The impact of the change in CPR is apparent in the graphs of projected yield and spread for the two securities (Exhibit 4). The low coupon of the GNR 2022-217 A is causing the deep discount in price, which reverses to substantial outperformance in scenarios where prepayment speeds increase. Obviously the reverse is true if speeds continue to slow, and the TBA outperforms.
Exhibit 4: Faster speeds favor the GNPL because it’s at a deeper discount
Note: Scenario analysis from Bloomberg as of 1/6/2022. Constant CPR.
Source: Bloomberg, Amherst Pierpont
In a rising rate environment as speeds were decelerating and GNPL deals were consistently coming to market at discounts, it’s not surprising that investors chose to overweight Ginnie MBS as opposed to CMBS.
The good news for GNPL deals is that higher coupons are coming, and with that transition some closer to par priced or even premium deals are likely to print in the coming months. That should help collapse some of the performance difference between the two types of securities due to prepays, though the general trend for most front sequentials will still be to outperform TBAs as speeds increase, and vice versa as speeds slow.
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.
Copyright © 2023 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.