By the Numbers
Better value in UMBS TBA over Ginnie Mae TBA
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Investors should lean into UMBS TBA over Ginnie Mae TBA in production coupons like 5.5%s as the quality of the Ginnie TBA looks set to keep deteriorating. The price of the Ginnie TBA should fall relative to the conventional. The lower quality comes as originators put more FHA loans and smaller VA loans into Ginnie Mae custom pools, which raises the share of larger VA loans in TBA-deliverable multiple issuer pools. Bigger VA loans typically prepay more quickly when mortgage rates fall. Pay-ups for Ginnie Mae custom pools should also increase as the Ginnie Mae TBA worsens.
At the start of the year Ginnie Mae TBA traded roughly 5/32s above UMBS in 6.0%s and around 15/32s higher in 4.5%s, 5.0%s and 5.5%s (Exhibit 1). Things have changed as mortgage rates have dropped this year. At the recent low point on mortgage rates in October, the 4.5%s and 5.0% price spreads were around zero, the 5.5%s were -10/32s, and the 6.0%s were approaching -20/32s.
Exhibit 1. The price of Ginnie Mae TBA has fallen relative to UMBS TBA this year
Source: Bloomberg, Santander US Capital Markets
Part of the drop in price spreads since the start of August is due to lower mortgage rates (Exhibit 2). Mortgage rates for VA loans are generally lower than conventional rates, and the VA mortgage rate has fallen more than conventional and FHA rates. This means that the Ginnie Mae TBA is further in-the-money than the equivalent coupon UMBS TBA, so Ginnie Mae speeds should start to increase before conventional speeds.
Exhibit 2. Primary mortgage rates have fallen since the start of August
Source: Bloomberg, Santander US Capital Markets.
The growing concentration of VA loans and high balance loans in new Ginnie Mae pools is also contributing to lower price spreads. VA loans are known to refinance very quickly since many VA borrowers have good credit characteristics and have access to an efficient streamlined refinance. FHA borrowers have a streamlined refinance program but are generally lower credit quality and have proven less apt to use it. Conventional borrowers do not have a streamline refi program.
The VA share and average loan size of loans in new multiple issuer pools is likely to keep increasing and push price spreads even lower. As new multiple issuer pools are backed by a larger share of VA loans, the refinance risk in those pools grows. Ginnie Mae TBA prices fall, dropping the price spread over conventional and raising the pay-up for Ginnie Mae custom pools. The higher pay-ups encourage even more custom pool creation, which causes multi pool quality to spiral lower. This is discussed in detail here, and an update on recent production trends is here.
One way control for the influence of mortgage rates on price spreads is to compare the price spread for coupons near par at different times. Falling rates means that the par coupon was higher earlier in the year and lower more recently. Plotting the price spread for the 6.0% coupon against the price of the G2SF 6.0% TBA shows that this coupon has always traded above par this year (Exhibit 1). At the peak the price spread was over 15/32s above conventional, and in many periods the G2SF 6.0% TBA traded above the conventional TBA even when the Ginnie price exceeded $101; the price spread was only predominantly negative above $102.
Exhibit 3. G2SF 6.0%-FNCL 6.0% swap vs. G2SF 6.0% price
Source: Bloomberg, Santander US Capital Markets.
The price spread for the 5.5% coupon, however, was lower than the 6.0% swap at the same price of the Ginnie Mae TBA (Exhibit 4). For example, the price spread never exceeded roughly 13/32s when prices were above par, below the maximum price spread for the 6.0% coupon. And the spread was negative for prices above $100.75.
Exhibit 4. G2SF 5.5%-FNCL 5.5% swap vs. G2SF 5.5% price
Source: Bloomberg, Santander US Capital Markets.
The pattern is similar for the 5.0% coupon (Exhibit 5). It has only traded near par, not far above par, but around par the price spread was rarely above 10/32s and often close to zero. This coupon only approached par in September and October, so the lower spread at par likely reflects the lower convexity of new Ginnie Mae multiple issuer pools.
Exhibit 5. G2SF 5.0%-FNCL 5.0% swap vs. G2SF 5.0% price
Source: Bloomberg, Santander US Capital Markets.
The VA share of multi pools is likely to grow even more since there has been a pickup in refinance activity. Since VA borrowers refinance faster than FHA borrowers, VA loans should make up a greater share of total production than before the refinance wave. Most of these VA loans are likely to go into new multiple issuer pools. A similar pattern should play out with loan sizes, since higher balance loans refinance faster than smaller loans.
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