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By Joy Wiltermuth
NEW YORK, Aug 8 (IFR) - Several hedge funds have received
margin calls in recent days on their holdings of risk-sharing
RMBS bonds from Freddie Mac and Fannie Mae, market sources told
The sources said the margin calls were met, but the event
still unnerved the structured finance market, which has again
become reliant on cheap leverage to sustain momentum.
One banker said brokers' margin calls required the hedge
funds to pony up an extra four to five points of their equity
against what they initially borrowed to purchase the bonds -
understood to be more than 80% of the purchase price in some
cases - to cover any losses.
"Dealers that lead these trades offer attractive financing
of two to three times leverage," one mortgage strategist said.
"But if the investor is forced to unwind, it can get ugly."
In the first quarter, some hedge funds were locking in
30-day repurchase agreements to buy risk-sharing bonds at a rate
of 1.9% to lever 2.14 times, according to SEC filings.
Risk-sharing RMBS are barely a year old, having sprung up as
a new asset class after US regulators issued guidelines urging
the government to reduce its footprint in the massive US
residential mortgage market.
Hedge funds piled aggressively into the riskier (and often
unrated) tranches of the deals, looking for yield pick-up at a
time when returns had shrunk dramatically just about everywhere
But those deals have recently tumbled dramatically. Between
July 11 and July 29, the unrated bonds favoured by hedge funds
gapped out as much as 50bp to roughly Libor plus 330bp in the
secondary market, according to Wells Fargo data.
"Generally the sell-off has all the signs of a levered
unwind," the mortgage strategist said.
And at a time when volatility is high - Lipper this week
reported the largest one-week outflow from high-yield funds
ever, at more than US$7bn - the risk-sharing bonds are
continuing to struggle.
On Wednesday Freddie Mac had to price the unrated tranches
of its latest Structured Agency Credit Risk (STACR) trade at
Libor plus 400bp and 410bp - a whopping 100bp-120bp wide of
Fannie Mae's last risk-sharing deal in July.
And while cheap money certainly enticed some players to buy
into the risk-sharing sector in the first place, record volumes
lately have led players to look for a way to trade out.
Approximately US$135m in risk-sharing bonds was out for bid
in each of the past two weeks, the highest levels by far since
the programme started in July 2013, according to Adam Murphy,
president of market data company Empirasign.
Despite these stumbles, Freddie Mac is counting on being
able to attract a broader base of buy-and-hold investors to the
asset class - and remains optimistic.
For one thing, each of Freddie's four STACR deals prior to
July had printed at successively tighter levels, as did the
three prior Fannie trades.
"Maybe spreads tightened too much and are now back to a more
sustainable level," Mike Reynolds, a director of portfolio
management at Freddie Mac, told IFR.
"We definitely think the investor book should include hedge
funds, and it's natural for them to use to get the
yields they need," he said. "But we prefer to be a
smaller percent of the total distribution."
And that seems to be happening already. For the 2014-DN3
portion of the new STACR trade, 20% went to hedge funds, down
from a 30% participation in April for its DN2 deal, Reynolds
Meanwhile the 2014-HQ1 deal - the first from Freddie to
include mortgages with loan-to-values above 80% - saw just 5%
participation from hedge funds.
(Reporting by Joy Wiltermuth, additional reporting by Andrew
Park.; Editing by Marc Carnegie and Shankar Ramakrishnan)