By the Numbers
Patterns in Ginnie Mae-conventional OAS as rates rise and fall
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.
The difference between Ginnie Mae and conventional OAS seems to change predictably as interest rates move up and down. For MBS coupons trading above par, the Ginnie Mae OAS typically widens relative to conventional as rates fall and tightens as rates rise. Investors can lift performance relative to the MBS index by shifting exposure in premium coupons from Ginnie Mae to conventional when rates are high and expected to fall, and shifting from conventional to Ginnie Mae when rates are low and expected to rise.
The last month is a posterchild for a pattern that has repeated over the last few years. The OAS on conventional 4.5% and higher coupons widened over the last month as rates rose (Exhibit 1). The OAS on each coupon moved from a tighter or lower percentile rank on September 18 to a wider or higher percentile rank by October 22, the rank measured against the distribution of OAS for each coupon over the last five years. Unlike conventional MBS, the Ginnie Mae OASs tightened in 5.5%s through 6.5%s over the last month. In some coupons, the Ginnie OASs were wider than conventional in mid-September and are now tighter than conventional.
Exhibit 1. Conventional OASs widened, Ginnies tightened, for most higher coupons.
Source: Bloomberg, Santander US Capital Markets.
The 6% coupon illustrates that the spread between the Ginnie Mae OAS and conventional OAS typically widens when rates drop (Exhibit 2). The graph compares the daily change in the OAS difference, using Bloomberg’s BAM prepayment model, to the daily change in the 10-year US Treasury yield. Comparing the changes, rather than levels, is more robust to spurious correlation. The regression result is significant to a 0.1% level and shows that the Ginnie OAS should widen 2.3 bp relative to the conventional OAS when interest rates drop 10 bp. The R2 is 0.44, indicating that interest rate moves explain 44% of the OAS difference movements since the start of 2023.
Exhibit 2. The G2SF–FNCL OAS spread for 6%s tends to widen in a rally.
Data from January 2023 to present. R2 is 0.44. The slope is significant and implies 2.3 bp OAS widening in a 10 bp rate rally.
Source: Bloomberg, Santander US Capital Markets.
The regression result is consistent with the rate and OAS move over the last month—the 10-year Treasury yield increased 63 bp from September 16 to October 23, implying the OAS spread should tighten by 14.5 bp, which is 46% of the actual amount the OAS difference tightened over that same time. So higher interest rates were likely responsible for a large portion of the relative OAS change.
The OAS spreads for other cuspy and premium coupons show similar behavior to the 6%s (Exhibit 3). Bloomberg’s and Yield Book’s models both have Ginnie Mae OAS wider relative to conventional OASs when rates fall. The coefficients are somewhat larger for Bloomberg than Yield Book, but both models are highly significant in coupons 5% and higher. The middle of the stack—4%s and 4.5%s—have a smaller effect and the results are not quite as significant as in higher coupons.
Exhibit 3. Sensitivity of G2SF–FNCL OAS difference to rate changes
A positive coefficient indicates the bp increase (decrease) in the G2SF–FNCL OAS spread for a 10 bp increase in the 10-year UST yield. Regression from January 2023 to present. Bloomberg results use the production model as of 10/23/2024. Yield Book OAS history spans multiple model releases.
Source: Bloomberg, Santander US Capital Markets.
In discounts the OAS behavior changes direction—Ginnie Mae OASs widen relative to conventional OASs when rates increase, not decrease. The analysis is not significant for the 2.0% coupon and is only significant using Yield Book OASs for the 2.5% coupon.
The results suggest that in a high-rate environment, when there is more risk of a rally than another sell-off, it is better to allocate to premium conventionals and discount Ginnies; both those positions should be biased to tighten if rates fall. And if rates are relatively low and there is more risk of an increase, it is better to be in premium Ginnies and discount conventionals.
Other practitioners have done work on these sorts of errors. For example, this paper by Andrew Davidson and Alex Levin discusses some of the pitfalls of OAS analysis and pricing MBS, attributing the difference to the market’s view the risk that models may not capture prepayments. That view is consistent with these results—investors are typically more concerned about surprisingly faster Ginnie Mae prepayment speeds in a rally, and to a lesser extent more concerned about slow prepayment speeds from discount conventional MBS.
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