June 28 (IFR) - In the clearest sign yet that the US government is serious about its efforts to bring private capital back into the mortgage market, government-sponsored enterprise Freddie Mac has resurrected a concept that it abandoned 15 years ago: risk-sharing bonds.
The mortgage finance giant has begun marketing a new product, dubbed Freddie Mac Structured Agency Credit Risk (STACR) securities, designed to offload the first-loss piece of certain government-guaranteed MBS into the private capital markets.
The GSE attempted a similar product in 1998 that was largely deemed a failure. However, some in the MBS market say that the novel and complex STACR structure, which is still being fine-tuned before being pitched to investors for the next two weeks by underwriter and structurer Credit Suisse, has the potential to be a liquid and broadly sponsored new asset class if a handful of pilot deals are successful this year.
“The growing buyer base in legacy non-agency RMBS demonstrates the significant appetite for residential-mortgage credit risk, which investors have had very few avenues of access to for the last five years,” said Bryan Whalen, co-head of MBS investing at Los Angeles-based asset manager TCW.
“This new product from Freddie Mac gives this investor base access to not just a new type of non-agency RMBS credit, but to residential credit, period. If the GSEs are dedicated to this program and become consistent issuers, it can grow into a relatively liquid credit opportunity.”
One senior banker away from the lead but with direct knowledge of the product said: “This could create a benchmark for credit in the mortgage market. Freddie Mac wants this to become a broadly distributed liquidity product, and is expecting that dealers and investors will give it a lot of attention.”
The structure, which could prove complicated to model, will include provisions that will protect investors from the risk that borrowers either pre-pay their mortgages early (pre-payment risk) or that shifting interest rates affect bond prices (convexity risk).
A senior/subordinate “shifting interest” structure means that a portion of principal pre-payments due to the most subordinate bonds will be shifted to pay down the senior-most bonds first - creating a buffer protecting the highest-ranked slices. However, allocations to the senior-most bonds will decline over time.
The structure will also have tranching, or slicing up, of mezzanine bonds, and the first deal will be floating-rate, which reduces convexity risk.
Market sources with knowledge of the deal said that it comes in a “synthetic format”, in that it references a pool of recently originated mortgages and includes a mechanism so that the duration of the bonds doesn’t need to match the duration of the assets.
The banker said that it would be a “higher-yielding asset with a significant credit component” that would be marketed not only to traditional mortgage credit buyers, but also to high-yield and so-called crossover traders.
Credit Suisse declined to comment, and Freddie Mac did not return phone calls.
Freddie Mac has ambitious plans for the product and hopes to issue multiple deals this year, according to a pre-marketing announcement. It plans to become a programmatic issuer of the structure by 2014.
It is also widely expected that Fannie Mae, the larger mortgage GSE, will come out with a similar and coordinated product very shortly.
The Federal Housing Finance Agency (FHFA), which regulates the GSEs, hopes eventually to achieve consistency and regularity of issuance of STACRs from both entities, with a market evolved enough to offer predictability in terms of pricing levels and execution.
The risk-sharing bonds are part of an ongoing effort by the FHFA, 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 being wracked with losses due to the implosion of the non-agency RMBS market, have each been instructed by the FHFA to conduct US$30bn in various risk-sharing programs this year.
The FHFA’s other recent method to push mortgage finance back to the private market has been to steadily increase the GSE’s guarantee fees - or G-fees - the amount that they charge lenders and investors to guarantee loans.
However, lenders have pushed back on the spike in G-fees, and the risk-sharing transactions are viewed as one way to normalize them to market rates.
Credit Suisse worked on the structure with Freddie Mac for 18 months, sources said. However, even though an inaugural deal has been named - titled STACR 2013-DN1 - investors say the two-week roadshow is expected to be as much a due diligence endeavor as an opportunity to educate investors.
“Freddie Mac is still exploring all opportunities and trying to find out what attracts the most investors and most dollars,” said a securitization insider.
“They’re exploring investors’ needs and requests from a capital and cost standpoint. They will be good listeners during this roadshow.”
What’s more, while the first deal will consist of unrated notes, Freddie Mac is still exploring whether or not to obtain a credit rating for future iterations of the product, which would make it more palatable to a wider segment of investors.
One idea is to obtain a rating from the National Association of Insurance Commissioners, which since 2009 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 insurers.
STACR 2013-DN1 is expected to be split into two sequential-pay, unrated note tranches, issued at par as uncapped Libor-based floaters. It is designed to furnish credit protection to the GSE on a reference pool of recently originated loans.
Payments will be general obligations of Freddie Mac with characteristics similar to securities in senior/subordinate private-label RMBS structures.
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