The performance of Ginnie Mae bonds backed by adjustable rate mortgages has become easier to predict, according to analysts at Bear Stearns & Co.
The investment bank recently released results of its latest study of the prepayment behavior of such securities, based on data collected over the past three years, including information on borrowers refinance behavior that was not available for previous studies.
Armed with new information and more accurate prepayment analytics, investors can now perform a more rigorous analysis of the performance characteristics of [Ginnie Mae] securities, the report said.
Adjustable-rate mortgage borrowers tend to pay their loans off much more quickly than fixed-rate borrowers. However, Bear Stearns says it found that when interest rates fall, the speed of payment will increase much more for a fixed-rate conventional mortgage issue than for a Ginnie Mae ARM.
The report compares an adjustable-rate Ginnie Mae bond to a fixed-rate Fannie security. In the same interest-rate environment, 78% of the ARM-backed bond would be paid off during the first five years, compared to 41% for the fixed-rate security.
However, if interest rates were to fall 100 basis points, the payment speed for the ARM issue would increase just 9 percentage points, to 87%, while the speed for the fixed-rate issue would jump 28 percentage points, to 69%.
Bear Stearns found that several factors can slow the prepayment speeds of Ginnie ARM borrowers.
For one thing, these borrowers tend to have lower incomes and cannot make big down payments, so they are attracted to the lower loan-to-value ratios offered by FHA loans and the below-market rates offered by ARMs.
Hence these borrowers are often locked into their mortgages because they have little equity in their homes and need to build equity or increase their incomes before they can trade up for a better house.
Also, an FHA loan can be transferred when a home is sold. Even if a borrower sells the home there is a strong incentive for the new borrower to assume the existing loan, thereby preventing a prepayment, Bear Stearns said.