Bloomberg News

Dwarfs Chase Ginnie Midgets as Lenders Seek FHA Debt: Mortgages

June 01, 2012

Dwarfs Chase Ginnie Midgets as Lenders Seek FHA Deb

The midget market expanded in the past year because of the growth of FHA-insured lending beyond first-time home buyers or others with little cash or weak credit. Photographer: George Frey/Bloomberg

Midgets are losing ground to dwarfs in the mortgage bond market as borrowers lock in Federal Housing Administration loans ahead of fee increases.

Midgets, the name used by traders to describe 15-year mortgage securities guaranteed by Ginnie Mae, including FHA loans, fell last month by a record relative to 15-year Fannie Mae securities called dwarfs. The names refer to the loans’ maturities being shorter than more popular 30-year debt.

The midget market expanded in the past year because of the growth of FHA-insured lending beyond first-time home buyers or others with little cash or weak credit. Now, as the agency’s fee increases erode the relative attractiveness of the 15-year loans to borrowers who could qualify for Fannie Mae and Freddie Mac mortgages, lenders have flooded the market with Ginnie Mae bonds as the opportunity fades.

The temporary advantage offered by 15-year FHA loans “was something that we were taking advantage of in a big way over the last year or so,” said Bob Walters, chief economist at Detroit- based Quicken Loans Inc., the eighth-largest home lender. “Much of it is going to go away, and you’re seeing the tail end of all those case numbers starting to fund through.”

As Ginnie Mae’s 3.5 percent 15-year bonds fell, the premium over similar Fannie Mae debt shrunk in May to 1.3 cents on the dollar from about 2 cents, according to data compiled by Bloomberg.

Insurance Premiums

Borrowers with more home equity or bigger down payments have been getting 15-year FHA mortgages in the past year partly because financing backed by the agency with loan-to-value ratios of less than 78 percent doesn’t require any annual insurance premiums.

Homeowners that would otherwise pay as much as 1.25 percent a year instead only pay FHA’s upfront fees. Lenders have been able to cover those charges while still offering better rates than on Fannie Mae and Freddie Mac loans because of higher Ginnie Mae bond prices, according to Equity Now Inc., Norcom Mortgage and Quicken Loans. Premiums on midgets with 3.5 percent coupons peaked at a record 2.3 cents on the dollar in October.

“Somewhere along the line, around March 2011, we did a 15- year FHA loan and realized” that homeowners could get a better deal than with Fannie Mae loans, said Matt Hackett, underwriting manager at New York-based Equity Now. “Then we did a ton of them.”

Changing Math

That math is changing because of an increase in FHA’s upfront charges to 1.75 percent, from 1 percent. Lenders have six months to finish loans assigned case numbers before April 9 at the old premium levels. Equity Now is bringing to the attention of consumers who have a case number, which lenders can create for a pending application, “the advantageous position that they’re in,” said Hackett.

The FHA, which insures mortgages for refinancing and home purchases, has been raising premiums to bolster its finances and avoid a taxpayer bailout. The agency yesterday disputed a report that foreclosure starts on its loans spiked from March to April, while saying it does expect an increase after a $25 billion settlement that resolved legal disputes between officials and mortgage servicers over faulty foreclosures.

Fannie Mae and Freddie Mac have been sustained by almost $190 billion in aid since being seized in 2008. The three entities, along with other U.S.-backed programs, account for about 90 percent of new mortgages.

Fifteen-year loans carry higher monthly payments than 30- year debt, making them rare among FHA borrowers. Regulatory data on mortgage-bond trading this month through last week signals increased supply.

TBA Market

Daily volumes for Ginnie Mae 15-year securities with coupons of 3.5 percent or less averaged $180.5 million in the so-called specified pool market, or 10.9 percent of the total for Ginnie Mae, Fannie Mae and Freddie Mac 15-year debt. That compares with $90 million, or 6.2 percent, from mid-May 2011, when the data began being collected under the Financial Industry Regulatory Authority’s Trade Compliance and Reporting Engine.

In the so-called To Be Announced market, where forward contracts can be filled with bonds matching a range of characteristics, trading of the Ginnie Mae debt jumped to $1 billion, compared with a total of $5.3 billion over the period.

Outstanding midgets total about $45 billion, compared with the $5.4 trillion market for U.S.-backed mortgage securities. Ginnie Mae bonds often trade at higher prices than Fannie Mae and Freddie Mac securities, partly because they carry explicit government guarantees and have lower capital charges for banks.

Midgets were due for a correction because the premiums were too large, said Scott Simon, mortgage head at Pacific Investment Management Co., which runs the world’s largest bond fund.

‘Insanely High’

“We simply did not understand why banks would buy them where they were trading,” Simon said. “We thought they were insanely high.”

He wouldn’t say if Newport Beach, California-based Pimco is buying the bonds, which he said now trade at a “reasonable level.”

The fall may offer an opportunity to investors, according to Bank of America Corp. (BAC:US) analysts including Satish Mansukhani in New York.

“This decline in payups leaves midgets as one of the few sectors offering the yields that prevailed prior to the onset of the current rally,” the New York-based analysts wrote in a May 18 report.

One negative is the underlying loans, especially debt originated in 2011, have prepaid faster than similar Fannie Mae and Freddie Mac mortgages when new-loan rates generally appear to offer similar refinancing incentives to borrowers, the Bank of America analysts said.

Price Advantage

The difference is tied partly to FHA mortgages carrying even lower rates because of Ginnie Mae’s price advantage, and with the smaller gap going forward “converging rates will result in narrowing prepayment differentials,” the analysts said.

Rates on new 15-year mortgages fell to a record low 3.33 percent last week, down from last year’s high of 4.65 percent, according to Mortgage Bankers Association data. Fifteen-year FHA loans aren’t separately tracked.

Prepayments damage investors who buy bonds for more than face value by returning their cash at par and curbing interest payments. The 3.5 percent Ginnie Mae 15-year securities trade at almost 107 cents on the dollar, Bloomberg data show.

The relative price drop arose with the Federal Reserve failing to buy 15-year Ginnie Mae securities even as the central bank reinvests in the mortgage-bond market with proceeds from past purchases under a program begun in October. The Fed is acquiring 15-year Fannie Mae and Freddie Mac securities.

Knowing Options

Ginnie Mae is monitoring the decline, though isn’t concerned at this point, said Ted Tozer, president of the U.S.- owned corporation. “The market has ebbs and flows, and the market usually reaches equilibrium points over time,” he said.

Lenders aren’t necessarily losing their ability to find situations where 15-year FHA loans are cheaper than similar Fannie Mae debt, said Jim Morin, vice president of retail lending at Avon Connecticut-based Norcom Mortgage. Those can include homes with more than one unit or borrowers with lower credit scores who face Fannie Mae price adjustments, he said.

“It’s just about sometimes thinking outside the box and borrowers knowing about their options,” Morin said. At the same time not all consumers easily embrace FHA debt because “for some people, it’s like a dirty word when you start bringing up FHA.”

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net;

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Rob Urban at robprag@bloomberg.net


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