By the Numbers
Stay in Ginnie Mae
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.
The month of May turned a corner for the year in agency MBS and finally posted positive excess returns across most coupons with Ginnie Mae generally outperforming conventional MBS. Interest rates leveled off in late April and have fallen a little since mid-May, and volatility dropped throughout the month. Banks have generally been reinvesting paydowns and not growing their MBS portfolios while favoring Ginnie Mae MBS over conventional MBS. Ginnies look likely to keep outperforming..
Excess returns for conventional 30-year 3.5% and lower coupons—before accounting for special dollar rolls—have been negative throughout 2022 but turned positive in May. Many investors had been moving up-in-coupon as spreads widened and rates increased because higher coupon pools have less spread exposure than lower coupon pools. The 30-year 4.0% and 4.5% coupons generally outperformed because of this. Supply of those coupon pools has been light since mortgage origination often takes months to ramp up after a big rate move. In May, the best performance was in 3.0%s and 3.5%s, the former of which looked like the most undervalued part of the stack to start the month. Lower coupons also outperformed hedges this month, likely because money managers started covering their underweights in those coupons.
Exhibit 1. Conventional 30-year MBS excess returns (%)
Excess returns reported by the Bloomberg Barclays MBS Index.
Source: Bloomberg, Amherst Pierpont Securities
The Fed has been reinvesting MBS paydowns into new MBS but is poised to slow reinvestments in June. The Fed’s purchasing cycle starts in roughly the middle of the month, so it still plans to buy $18.1 billion MBS through June 13. After that, MBS purchases are likely to be only a few billion per month through mid-September; the precise amount will depend on prepayment speeds as the Fed plans to cap runoff at $17.5 billion a month, so the net amount of MBS purchased by other investors should increase by that amount. Starting in mid-September the cap will increase to $35 billion a month, which should be much higher than actual runoff, and the Fed’s MBS buying will fall to de minimis levels.
Ginnie Mae also posted positive excess returns for most coupons in May. Bank demand for Ginnie Mae MBS is increasing since the better capital treatment helps banks reduce risk-weighted assets and improve liquidity coverage ratios. An FHA official mentioned in May that there are daily discussions about lowering mortgage insurance premiums. This should not have much effect on most outstanding pools since they are generally well out-of-the-money to refinance. However, 30-year 4.5% and higher coupon pools are priced above par and would be hurt if premiums drop and prepayment speeds increase, which may explain the underperformance in those coupons.
Exhibit 2. Ginnie Mae MBS excess returns (%)
Excess returns reported by the Bloomberg Barclays MBS Index.
Source: Bloomberg, Amherst Pierpont Securities
Exhibit 3. Conventional MBS excess returns have favored higher coupons
Excess returns reported by the Bloomberg Barclays MBS index. Excess returns are cumulative starting January 1.
Source: Bloomberg, Amherst Pierpont Securities
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