Ginnie Mae Extension Risk - Well, Assume Me!

Well, pardon me, but I hope you’re sitting down.

My data sources go back to the 1970’s when Steve Martin perfected his “Well, Excuse Me” routine, as described on page 160 of his wonderful book - Born Standing Up.

But I can’t recall the last time that fixed mortgage rates were this low, aside from the mortgage rally of the early 21^st century, which many now claim to despise.

This is important, and will become more so, as we continue to rediscover the joys of the mortgage financing system that prevailed prior to the Savings and Loan crisis of the 1980’s. Specifically:

• Fixed rate government guaranteed mortgages;
• Held on balance sheet; and
• Funded by cheap deposits.

To refresh your memory, examine the following chart:

Figure 1: 30 Year Fixed Rate Conventional and FHA Mortgage Rates, Since 1971

As indicated, my weekly feed of conventional rates extends back to 1971, and FHA rates go back to 1990.

As of early Jan 2009, the MBA reported that 30 year FHA rates were about 5.25%, while Freddie’s 30 year “Primary Mortgage Market Survey” rate was just above 5.00%.

Mind you, these are primary rates. Secondary government and conventional 30 year fixed rates were, of course, lower – and “tied” as of the 12 Jan close, at 3.79%.

Mortgage rates, by getting small, have heeded Steve Martin’s advice.

Facing the recession’s next leg, investors are understandably focusing upon the return OF their principal. But one of these days they will again attend to the return ON their principal.

When that day comes, they should recall both the chart above as well as my tribute to Martin’s signature line – Well, Assume Me!

That’s because, FHA loans – unlike their conventional counterparts, are assumable. As HUD lays out in the answer to Question #85 of its 100 Questions & Answers for future homebuyers:

Figure 2: HUD, 100 Questions and Answers - Question 85.

Above is one question that HUD believes 21^st century homeowners should ask.

As 21^st century investors, you may want to recall the advice that PaineWebber gave fixed income investors at the turn of this century:

Figure 3: From PaineWebber Mortgage Strategist - Rethinking GNMA Assumptions, 1 Aug 2000.

As PaineWebber subsequently noted in the same Aug 2000 article, HUD’s post-1990:

1. Imposition of “credit checks” (mentioned in “Question 85, see Figure 2); as well as a
2. New prohibition against private investor (as opposed to homeowner) assumptions

appear to have reduced the proportion of assumptions by 80% (from 1 – 2 % per year to 0.3% per year).

Relatively recently, Ginnie Mae had been a small player in the MBS market. However, as HousingWire noted at year’s end - Ginnie Mae Issuance Surpasses GSEs, Again - Ginnie Mae has become a key factor in the revitalization of the housing market, with Ginnie Mae’s President observing:

Ginnie Mae has consistently provided liquidity to the market and it is no surprise that our November MBS issuances were strong. It is further proof that Ginnie Mae is continuing to thrive and provide stability.

This has been reflected in Ginnie Mae’s increased market share, relative to that of Fannie Mae (FNM) and Freddie Mac (FRE), as indicated in Figure 4 below:

Figure 4: Ginnie Mae’s Substantial Year End MBS Share

Consequently, Ginnie Mae investors should attempt to, if they can, pick their investments with care.

They may be holding onto to their GNMA MBS, which they purchased when the current coupon was at 3.79%, for a long time.

Comments

[surferdude808:]

extension risk is huge in this environment and much greater for portfolio lenders. newly originated low coupon mortgages are going to stay on balance sheets for a very long time; therefore, you better love these loans. this is also an issue with loan mods, particularly anyone following the fdic "mod in a box" program, which calls for lowering the coupon to 3% and maturities up to 40 years. if anyone knows how a portfolio lender can effectively fund these mortgages please let us know. btw, the cost of this funding for portfolio is not even considered in the fdic test to determine if the mod should be performed. low coupon, long duration mortgages were what killed the thrift industry when intrest rates exploded in the 1970s. if the majority of outstanding mortgage loans get re-written at low coupons, then the seeds of the next crisis are being sown as this rate environment will not last forever.

Jan 14 09:02 AM

[Ira Artman:]

Yes, yes, and yes! When folks ask:

Who will pay for the mortgage crisis and the bailout?

the "easy" answer is "taxpayers" or "all of us."

Once you realize that we are probably [!] about to replay the S&L crisis of the 1980's:

1. balance sheet lending,
2. low rate mortgage assets,
3. funded by deposits that become too expensive once
rates move up as inflation reasserts itself,
4. due to ill-conceived programs that are funded with
loose money/printing press

It should be clear that

1. Before taxpayers are called again to pay for losses of balance sheet lenders (and are there any lenders these days, OTHER than balance sheet lenders - I think not)

2. the equity investors in balance sheet lenders may be wiped out as their low fixed rate mortgage asset heavy balance sheet can not be funded by shorter term deposits as the deposit rates reset upward.

But who remembers the 1980's?

Thanks for reading. - Ira

Jan 14 10:52 AM

[Palmer Heenan:]

I I believe proper accounting treatment would require some recognition (by the owner of the asset) of the loss that will be realized (well into the future) by the modification to a below market rate. I think by driving down the "market rates" the government is attempting to reduce the loss that lenders must recognize by making these reductions. Of course, you are right to point out that the cost will be born by the taxpayers (us). This is true whether we liquidate the properties (and ultimately the balance sheet lenders that hold them) and recognize those losses immediately, or artificially reduce rates to postpone those losses into the future (somewhat). I think the government also believes that if rates are pushed low enough it may have a chance to reinflate real estate. Probably this will come to naught as well. But such further artifices are probably the only chance to avoid taking all the medicine at once. I question how long and how much the government can continue to grow its balance sheet in this endeavor.....


On Jan 14 09:02 AM User 296970 wrote:

> extension risk is huge in this environment and much greater for portfolio
> lenders. newly originated low coupon mortgages are going to stay
> on balance sheets for a very long time; therefore, you better love
> these loans. this is also an issue with loan mods, particularly anyone
> following the fdic "mod in a box" program, which calls for lowering
> the coupon to 3% and maturities up to 40 years. if anyone knows how
> a portfolio lender can effectively fund these mortgages please let
> us know. btw, the cost of this funding for portfolio is not even
> considered in the fdic test to determine if the mod should be performed.
> low coupon, long duration mortgages were what killed the thrift industry
> when intrest rates exploded in the 1970s. if the majority of outstanding
> mortgage loans get re-written at low coupons, then the seeds of the
> next crisis are being sown as this rate environment will not last
> forever.

Jan 20 09:35 PM