If Fee Stooges was my most serious post, THIS post could be the most compelling, particularly for those of you who originate, service, or invest in GNMA’s. 

As noted in my Fee Stooges of 30 Oct, or by Housing Wire’s Paul Jackson on 7 Nov, GNMA originations and issuance have surged:

“In October, fixed issuance volume from Ginnie Mae … surpassed similar issuance volumes from either Fannie … or Freddie. According to [issuance] data provided to HousingWire by eMBS, Inc., [Ginnie] fixed [rate MBS] issuance … rose to $27.8 billion, while Fannie saw fixed issuance fall to $27.7 billion; … and Freddie posted just $14.4 billion in fixed issuance volume…

“Ginnie issuance has not topped either GSE since the mid-1980s.

“The growth of Ginnie Mae says as much about the resurgence of FHA loan products in the nation’s ailing mortgage market as it does about the shrinking violets that have become the GSEs in the wake of their conservatorship with the Federal Housing Finance Agency…” [Source: Housing Wire]

Today’s:

1. weak economic environment,
2. rising unemployment rate (one that includes your very humble author),
3. government “bailout [programs] for troubled homeowners“, 
4. prospects for lower interest rates, and
5. surge in GNMA issuance (see above)

are precisely the factors needed to seed the clouds and create conditions perfect for future rain and payment delays.

[Note: Since the phrase “Perfect Storm” received this year’s top prize from Lake Superior State University as the most-overused phrase that should be banished  – it describes an event where a combination of circumstances drastically aggravates a situation – I will not use it here.]

As a result, ANY mortgage backed security (MBS) investor should realize that they will probably be playing in the GNMA ballpark, whether or not they a) like it, or b) have any prior GNMA investing experience. They will need to adapt their investment strategy to the park’s peculiar set of changing ground rules and environment. GNMA servicers will need to make similar adjustments with respect to their current buyout strategy and procedures.

Pay attention – this is an “ambitious” post and I’ll be moving quickly.

This post will focus on basic definitions as well as the ever-changing (see below) ground rules governing GNMA Buyouts. In addition, it will also  provide you with a series of links to assist you in your own independent research on the topic.

Why do GNMA Buyouts matter? Read on. [Note:  See References for additional resources on topic.]

For those of you that are still rookies, a “GNMA Buyout” refers to the ability that a GNMA servicer has to buy delinquent FHA/VA loans out of a GNMA pool.

HUD/GNMA layout the ground rules in APM 02-24, as well as Chapter 18, Section 3 (18-3) of the GNMA MBS Guide.

Last week (7 Nov 2008), perhaps in reaction to that-which-shall-not-be-called-Perfect-Storm (see above), GNMA changed the rules with respect to the repooling of GNMA Buyouts in All Participants Memorandum  APM 08-23 as it clarified the intent of the buyout rules. “Perfect Storm” or not, bases are loaded, and the count is full.

Let’s first bring in the clarification or “set up” pitch(er) from APM 08-23:

“…this policy is to provide Issuers with sufficient flexibility to employ appropriate loss mitigation strategies for borrowers at risk of foreclosure.

“Ginnie Mae encourages its Issuers to identify such loans as soon as possible, and to pursue loss mitigation strategies consistent with guidance from the FHA [and] VA …

“While issuers are prohibited from modifying the terms of loans held in Ginnie Mae pools, certain loss mitigation strategies … may be accomplished without repurchase of the delinquent loan from the pool.”

And here is APM 08-23’s “relief” pitch(er), with special emphasis:

Simply put, while GNMA will still permit GNMA servicers to buy-out delinquent loans from GNMA pools when they are “at least” 90 days delinquent (at a price of  par, i.e. of 100.00), they are now placing additional restrictions on the ways in which bought out loans can be repooled … in GNMA’s. All else being equal, this may reduce the value, to the servicer, of the loans that were obtained (by buying them out) at a price of par.

What’s the “par” FHA/VA loan worth? Interesting question.

Generally speaking, loans with higher note rates trade at higher prices than similar loans with lower note rates. But years ago (see references), secondary market investors would set prices for delinquent bought out FHA/VA loans that were:

a) well above [!] par if the delinquent FHA/VA loans were seasoned and featured higher-than-current-market note rates; and

b) also well above above the prices paid for current FHA/VA loans with similar note rates.
Source: UBS Mortgage Strategist, Reperforming Collateral, The Case For Out-Performance, 3 Aug 2004. See Table 2, Page 20.

Why?

GNMA MBS are guaranteed by the full faith and credit of the US government, a guarantee that – even today – is a stronger guarantee than that provided to investors in Fannie or Freddie obligations. But … as long as the agencies’ rules are followed, an FHA-insured or a VA-guaranteed loan has the backing of the US government, whether or not the loan is in a GNMA MBS pool or not.

In contrast, the agency/GSE “backing” for conventional loans pooled into Fannies or Freddies exists only as long as the loan is within the MBS. If a conventional loan is bought out of a GSE pool by a servicer – say, to facilitate a modification – the loan would simply be “backed” by the value of the home, the assets of the borrower, and (possibly) by any PMI or LPMI (borrower or lender-paid mortgage insurance.)

Consequently, the government insurance/guarantee backing FHA/VA loans eliminates much of the credit risk that investors would normally experience if they were to invest in a pool of delinquent loans with high note rates that represent obligations of borrowers who cannot refinance into lower note rates due to their relatively poor credit/delinquency history.

Normally loans with higher-than-market rates tend to pay off faster, all else being equal, than similar loans with lower note rates.

Delinquent borrower face two obstacles that constrain their prepayment options. First, their poor credit histories limit their access to the best and lowest mortgage rates. Second, before they can refinance their existing loan, they will need to come up with the cash required to bring the delinquent loans current. In effect, delinquency creates a prepayment penalty – the cash needed to become current.

If they don’t have the cash to become current, they can’t refinance their loan.  As a result, they prepay more slowly than “similar” current loans.  When home prices were rising sharply (prior to 2006), delinquent borrowers might have tapped their home equity in a cash-out refi to cover the costs of becoming current as well as the closing costs of the new loan with (presumably) a lower interest rate. But that was then.

As for now, we’ll just have to wait-and-see what happens to the five factors (listed above), as well as any additional clarifications or guidance with respect to the governing ground rules. 

Until then, I plan on keeping my eye on the ball.

If you can’t wait, and would like to discuss the possible implications of a GNMA-dominated mortgage world with a weak housing and economic environment, you can get in touch with me .

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I used to work with numbers for a living, but now I’ll try not to balk as I look for my next job or ‘idea’. Till next time.

REFERENCES [Accessed 8 Nov 2008]

HUD/GNMA, All Participants Memorandum (APM 08-23) [pdf], 7 Nov 2008.

 
I. Artman, Sterling Slivers – Fee Stooges, 30 Oct, 2008.

Ginnie Mae, MBS Guide.

 
HUD, Single Family FHA Insured Mortgage Programs.
HUD/FHA, HOPE for Homeowners Home Page.

P. Jackson, HousingWire – GNMA Makes Mortgage Market History In October, 7 Nov 2008.

L. Goodman, et.al., UBS Mortgage Strategist – Reperforming Collateral, The Case For Out-Performance, 3 Aug 2004. Note: Two firms that covered this sector extensively were Goldman Sachs & Barclays (nee Lehman Brothers), usually under the title of “FHA/VA Reperformers” or something similar. 

Lake Superior State University, 2008 List of Banished Words.

 
E. Razzi, Washington Post – Hope for Homeowners,’ Still Long in Coming, 28 Sep 2008.

 
US Department of Veterans Affairs – Fact Sheet on VA Guaranteed Loans.

 
Michael Fix, Something’s Cooking – Can’t Buy Me Love/Drive My Car, Rhapsody/Fret Music, 2005.
Michael Fix, Something’s Cooking – Slow Food, Rhapsody/Fret Music, 2005.