Ginnie Mae TBAs rally with the bond 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—like to 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. However, there’s 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.
Since you can have more certainty with 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 MBS unchanged
The front-month Ginnie Mae TBAs were bid up as bonds rallied eight basis points. Ginnie Mae TBAs began the week at 106 21/32 and ended up in the same place. The underlying bond market sold off 12 basis points.
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. Rising rates hurt the value of their mortgage-backed security holdings. The REIT sector spent most of 2013 deleveraging to position itself 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. As interest rates rise, the expected maturity of the bond increases because 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 have to adjust their hedges and buy more protection when prices are high. 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, which have an identical credit risk—none.