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Ginnie Mae TBAs Shrug Off the Bond Market Sell-off

Brent Nyitray, CFA, MBA

This Week's Key Highlights from the Real Estate Market (Part 6 of 6)

(Continued from Part 5)

Ginnie Mae and the to-be-announced market

The Fannie Mae to-be-announced (or TBA) market represents the usual conforming loan, the plain Fannie Mae 30-year mortgage. Meanwhile, Ginnie Mae TBAs are where government loans go, such as the Federal Housing Administration (or FHA) and Veterans Affairs (or VA) loans.

The biggest difference between a Fannie Mae mortgage-backed security (or MBS) and a Ginnie Mae MBS is that Ginnies have an explicit guarantee from the federal government. Fannies don’t have a guarantee, just a wink-wink, nudge-nudge guarantee. As a result, Ginnie Mae MBS trade at a premium compared to Fannie Mae TBAs.

There are two Ginnie Mae TBAs: Ginnie 1s and Ginnie 2s. Ginnie 1 TBAs include mortgages with the same coupon payment. Ginnie 2 TBAs can include a variety of coupons within a range.

Since you can have more certainty with the Ginnie 1s compared to the 2s, the 1s typically trade at a premium. This premium can vary. You’ll often see investors switch between 1s and 2s as a relative value trade. The Ginnie Mae 1s tend to be more liquid than the 2s and have narrower bid-to-ask spreads.

Ginnie Mae mortgage-backed securities end up unchanged

The ten-year bond sold off with yields increasing from 2.08% to 2.16%. Ginnie Mae TBAs were more or less unchanged at 104.91.

Implications for mortgage REITs

Mortgage real estate investment trusts (or REITs) such as Annaly Capital Management (NLY), American Capital Agency (AGNC), MFA Financial (MFA), and Capstead Mortgage Corporation (CMO) announced big drops in book value per share. Rising rates hurt the value of their mortgage-backed security holdings. The REIT sector spent most of 2013 deleveraging to position itself for rate increases.

As a general rule, a lack of volatility is good for mortgage REITs and the mortgage REIT ETF (MORT), which hedges some interest rate risk. Increasing volatility in interest rates increases the cost of hedging. As interest rates rise, the expected maturity of the bond increases because there will be fewer prepayments. On the other hand, if interest rates fall, the maturity shortens due to higher prepayment risk.

Mechanically, this means mortgage REITs have to adjust hedges and buy more protection when prices are high. Then, they have to sell more protection when prices are low. This buy-high, sell-low effect is called negative convexity. It explains why Ginnie Mae MBS yield so much more than Treasuries, although neither have credit risk.

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