In a recent webinar, RiskSpan’s Fowad Sheikh engaged in a robust discussion with two of his fellow industry experts, Mahesh Swaminathan of Hilltop Securities and Mike Ortiz of DoubleLine Group, to address the likely road ahead for Ginnie Mae securities performance.
The panel sought to address the following questions:
- How will the forthcoming, more stringent originator/servicer financial eligibility requirements affect origination volumes, buyouts, and performance?
- Who will fill the vacuum left by Wells Fargo’s exiting the market?
- What role will falling prices play in delinquency and buyout rates?
- What will be the impact of potential Fed MBS sales.
This post summarizes some the group’s key conclusions. A recording of the webinar in its entirety is available here.
Wells Fargo’s Departure
To understand the the likely impact of Wells Fargo’s exit, it is first instructive to understand the declining market share of banks overall in the Ginnie Mae universe. As the following chart illustrates, banks as a whole account for just 11 percent of Ginnie Mae originations, down from 39 percent as recently as 2015.
Drilling down further, the chart below plots Wells Fargo’s Ginnie Mae share (the green line) relative to the rest of the market. As the chart shows, Wells Fargo accounts for just 3 percent of Ginnie Mae originations today, compared to 15 percent in 2015. This trend of Wells Fargo’s declining market share extends all the way back to 2010, when it accounted for some 30 percent of Ginnie originations.
As the second chart below indicates, Wells Fargo’s market share, even among banks has also been on a steady decline.
Three percent of the overall market is meaningful but not likely to be a game changer either in terms of origination trends or impact on spreads. Wells Fargo, however, continues to have an outsize influence in the spec pool market. The panel hypothesized that Wells’s departure from this market could open the door to other entities claiming that market share. This could potentially affect prepayment speeds – especially if Wells is replaced by non-bank servicers, which the panel felt was likely given the current non-bank dominance of the top 20 (see below) – since Wells prepays have traditionally been slightly better than the broader market.
The panel raised the question of whether the continuing bank retreat from Ginnie Mae originations would adversely affect loan quality. As basis for this concern, they cited the generally lower FICO scores and higher LTVs that characterize non-bank-originated Ginnie Mae mortgages (see below).
These data notwithstanding, the panel asserted that any changes to credit quality would be restricted to the margins. Non-bank servicers originate a higher percentage of lower-credit-quality loans (relative to banks) not because non-banks are actively seeking those borrowers out and eschewing higher-credit-quality borrowers. Rather, banks tend to restrict themselves to borrowers with higher credit profiles. Non-banks will be more than happy to lend to these borrowers as banks continue to exit the market.
Effect of New Eligibility Requirements
The new capital requirements, which take effect a year from now, are likely to be less punitive than they appear at first glance. With the exception of certain monoline entities – say, those with almost all of their assets concentrated in MSRs – the overwhelming majority of Ginnie Mae issuers (banks and non-banks alike) are going to be able meet them with little if any difficulty.
Ginnie Mae has stated that, even if the new requirements went into effect tomorrow, 95 percent of its non-bank issuers would qualify. Consequently, the one-year compliance period should open the door for a fairly smooth transition.
To the extent Ginnie Mae issuers are unable to meet the requirements, a consolidation of non-bank entities is likely in the offing. Given that these institutions will likely be significant MSR investors, the potential increase in MSR sales could impact MSR multiples and potentially disrupt the MSR market, at least marginally.
Potential Impacts of Negative HPA
Ginnie Mae borrowers tend to be more highly leveraged than conventional borrowers. FHA borrowers can start with LTVs as high as 97.5 percent. VA borrowers, once the VA guarantee fee is rolled in, often have LTVs in excess of 100 percent. Similar characteristics apply to USDA loans. Consequently, borrowers who originated in the past two years are more likely to default as they watch their properties go underwater. This is potentially good news for investors in discount coupons (i.e., investors who benefit from faster prepay speeds) because these delinquent loans will be bought out quite early in their expected lives.
More seasoned borrowers, in contrast, have experienced considerable positive HPA in recent years. The coming forecasted decline should not materially impact these borrowers’ performance. Similarly, if HPD in 2023 proves to be mild, then a sharp uptick in delinquencies is unlikely, regardless of loan vintage or LTV. Most homeowners make mortgage payments because they wish to continue living in their house and do not seriously consider strategic defaults. During the financial crisis, most borrowers continued making good on their mortgage obligations even as their LTVs went as high as the 150s.
Further, the HPD we are likely to encounter next year likely will not have the same devastating effect as the HPD wave that accompanied the financial crisis. Loans on the books today are markedly different from loans then. Ginnie Mae loans that went bad during the crisis disproportionately included seller-financed, down-payment-assistance loans and other programs lacking in robust checks and balances. Ginnie Mae has instituted more stringent guidelines in the years since to minimize the impact of bad actors in these sorts of programs.
This all assumes, however, that the job market remains robust. Should the looming recession lead to widespread unemployment, that would have a far more profound impact on delinquencies and buyouts than would HPD.
Fed Sales
The Fed’s holdings (as of 9/21, see chart below) are concentrated around 2 percent and 2.5 percent coupons. This raises the question of what the Fed’s strategy is likely to be for unwinding its Ginnie Mae position.
Word on the street is that Fed sales are highly unlikely to happen in 2022. Any sales in 2023, if they happen at all, are not likely before the second half of the year. The panel opined that the composition of these sales is likely to resemble the composition of the Fed’s existing book – i.e., mostly 2s, 2.5s, and some 3s. They have the capacity to take a more sophisticated approach than a simple pro-rata unwinding. Whether they choose to pursue that is an open question.
The Fed was a largely non-economic buyer of mortgage securities. There is every reason to believe that it will be a non-economic seller, as well, when the time comes. The Fed’s trading desk will likely reach out to the Street, ask for inquiry, and seek to pursue an approach that is least disruptive to the mortgage market.
Conclusion
On closer consideration, many of these macro conditions (Wells’s exit, HPD, enhanced eligibility requirements, and pending Fed sales) that would seem to portend an uncertain and bumpy road for Ginnie Mae investors, may turn out to be more benign than feared.
Conditions remain unsettled, however, and these and other factors certainly bear watching as Ginnie Mae market participants seek to plot a prudent course forward.
