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Why Ginnie Mae securities drifted higher after the jobs report

Brent Nyitray, CFA, MBA

Important releases to watch for as earnings season starts off (Part 3 of 6)

(Continued from Part 2)

Ginnie Mae TBAs represent the mortgage-backed security for government mortgage loans

While Fannie Mae TBAs represent the usual conforming loan—the plain vanilla Fannie Mae 30-year mortgage—Ginnie Mae TBAs are where government loans like FHA and VA loans go. The biggest difference between a Fannie Mae MBS and a Ginnie Mae MBS is that Ginnies have an explicit guarantee from the Federal government. Fannies do not, although there is a “wink wink, nudge nudge” guarantee. As a result, Ginnie Mae MBS trade at a premium to Fannie Mae TBAs.

There are also two different Ginnie Mae TBAs: Ginnie 1s and Ginnie 2s. Ginnie 1 TBAs include mortgages with the exact same coupon payment. Ginnie 2 TBAs can include a variety of coupons within a range. Because the investor can have more certainty with Ginnie 1s versus the 2s, the 1s typically trade at a premium. This premium can vary, and often you’ll 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 MBS follow bonds higher after a so-so jobs report

The front-month Ginnie Mae TBA drifted higher as bonds rallied on the jobs report. After starting the week at 105 4/32, they traded 1/8 higher to close at 105 8/32.

Implications for mortgage REITs

Mortgage REITs—like Annaly Capital (NLY), American Capital (AGNC), MFA Financial (MFA), and Capstead Mortgage (CMO)—announced big drops in book value per share, as rising rates hurt the value of their mortgage-backed security holdings. The REIT sector spent most of 2013 de-leveraging to position themselves for increases in rates.

As a general rule, a lack of volatility is good for mortgage REITs and the mortgage REIT ETF (MORT) because they hedge some of their interest rate risk. Increasing volatility in interest rates increases the cost of hedging. This is because as interest rates rise, the expected maturity of the bond increases, as there will be fewer pre-payments. On the other hand, if interest rates fall, the maturity shortens due to higher pre-payment risks. Mechanically, this means mortgage REITs must adjust their hedges and buy more protection when prices are high and sell more protection when prices are low. This “buy-high, sell low” effect is called “negative convexity,” and it explains why Ginnie Mae MBS yield so much more than Treasuries that have identical credit risk (which is to say none). Investors who want to make directional bets on Treasuries should look at the iShares 20 year bond ETF (TLT).

Continue to Part 4

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