July 26 (IFR) - Bank buyers kept their distance from the
inaugural Freddie Mac risk-sharing mortgage bond this week,
fearful of punitive risk-weighting charges on the new type of
security, according to industry experts.
Barely a handful of banks bought the US$500m of securities,
which were upsized from US$400m at pricing. Insurance companies
were also not the most active buyers, as they would have liked
the security to have a rating from the US National Association
of Insurance Commissioners (NAIC), sources said.
About 50 investors bought the unrated Structured Agency
Credit Risk (STACR) 2013-DN1, including hedge funds, pensions,
money managers, REITs, credit unions, and a few insurance
Spreads initially widened considerably from initial price
whispers last week, but then tightened in at pricing on Tuesday.
The two-tranche structure offered tenors of 2.19 and 8.21-years,
respectively. Pricing levels were set at one-month Libor plus
340bp and 715bp.
Even though the new bond is considered an obligation of
Freddie Mac, the typical 20% risk weighting assessment
for Fannie and Freddie agency MBS would not be applied to this
Some of the first-loss risk is being laid off to the private
capital markets, and the deal is closer to a senior/subordinate
private-label RMBS. The risk-weighting charge would likely be
much higher if banks held the security.
"It's difficult for banks to invest in this; the risk
weightings would matter to them," said Kevin Palmer, the vice
president of costing and portfolio management at Freddie Mac.
"We did meet with some banks, but it's unclear what the risk
weighting would be," given some of the complex formulas
currently being suggested under Basel III rules to formulate
charges for risk-weighted assets, including structured products
held by banks.
There will likely be one more STACR transaction toward the
end of 2013, and "then we will determine the appropriate
issuance frequency in 2014," Palmer told IFR. "Our goal is to
have standardized structuring and consistent frequency of
issuance, making the product more predictable."
Consistent feedback from investors reflected the fact that
they would prefer to have the next transaction rated, said
"There is only so much capital investors can put into
unrated assets," he noted. "We are working with rating agencies
to have it rated in the future."
Money managers, in particular, were pressing for
rating-agency grades, since ratings give them more flexibility
to put the STACR bonds into funds.
Freddie Mac is also in preliminary talks with the NAIC to
potentially rate the bonds so that more insurance companies can
hold them. Typically, the NAIC does not rate new offerings, but
assigns grades once the securities are held in insurance-company
"We are working with the NAIC to be able to give some sort
of rating to these bonds once they are in insurers' portfolios,"
Palmer said. "With NAIC ratings, I think participation from
insurance companies will increase quite dramatically."
Since 2009 the NAIC has been providing US insurance
companies and regulators with credit assessments of legacy RMBS
and CMBS in order to estimate risk-based capital requirements.
The NAIC's alternative approach to ratings, which differs
from credit rating agency grades, has been viewed by many in the
market as a more precise assessment of the value of RMBS held by
Another favorable trait of the first STACR deal is that
there is no concept of so-called "servicing advances" in the
structure. In typical non-agency RMBS deals, servicers must put
money up front for loans that have become delinquent; therefore,
servicer advances are typically an important part of how
investors will bid on deals.
Investors usually scrutinize who the servicer is, and how
much has been advanced.
In the Freddie Mac STACR transaction, however, the GSE pays
full coupon to investors the entire time the loan is in the
structure. Moreover, the structurers tried to limit investors'
downside risk by deploying a fixed, but tiered, loss-severity
structure, which protects against unforeseen and hard-to-predict
During the last downturn, for instance, foreclosure
timelines were extended, and there were many new laws put in
place in various municipalities that extended the timelines even
further. This meant increased risk for holders of RMBS.
On the flip side, however, some bond investors complained
that the fixed severities in Freddie's deal also limits their
upside, should the market improve, which Palmer said was a
somewhat fair statement.
However, the "tiered" severity structure accounts for both
high levels of "curing" of mortgage defaults in a good market,
or an increase in loss severities as the market deteriorates.
In fact, the lack of this "tiering" in the fixed loss
severities is partially what derailed an earlier attempt at
risk-sharing bonds by the GSE in 1998, Palmer said.
Freddie attempted a somewhat similar product that year,
called Mortgage Default Recourse Notes (MODERNS), a one-off
insurance-like derivatives transaction that exhibited numerous
structural and conceptual weaknesses, and was largely deemed a
Market players describe that effort as an attempt to create
a "funded alternative to mortgage insurance".
The STACR deals bear structural similarities to MODERNS, but
have a different purpose -- bringing private capital back into
mortgage finance -- and are being released into a different
"We're trying to limit policy risk to investors," Palmer
said. "We don't do principal forgiveness, but if we ever did it,
the portion of principal forgiven would be passed through to
investors," meaning that bond investors wouldn't take any loss
on the principal forgiven to borrowers.
"We're limiting investors' exposure to policy changes
they're concerned about."
The risk-sharing bonds are part of an effort by the GSEs'
regulator, the Federal Housing Finance Agency, and the US
government, to gradually wind down and phase out the GSEs'
overwhelming footprint in the market. The two companies
currently finance nearly 90% of the country's mortgages.
The taxpayer-backed organizations, which were put into
government conservatorship in 2008 after suffering heavy losses
due to the implosion of the non-agency RMBS market, have been
instructed by the FHFA to conduct US$30bn in various
risk-sharing programs this year.