August 28, 2014 / 7:00 PM / 5 years ago

Legacy RMBS hold upper hand over new mortgage trades

NEW YORK, Aug 28 (IFR) - RMBS left over from the wreckage of the subprime crisis are finding renewed favor with investors, siphoning off demand for new mortgage-backed instruments by offering juicier yields.

Once the darlings of the market - and then later the pariahs - these legacy deals are now denting demand for the new breed of single family rental (SFR) securitizations and risk-share trades.

“In legacy subprime you can still find bonds with credit enhancement,” said Harrison Choi, co-head of the securitized products division of TCW.

“If you pick the right ones, there are bonds that could return par or all of your principal,” he said.

According to JP Morgan data, the market for these bonds is still a robust US$850bn - well off the pre-crisis high of US$2.4trn in 2007 but still significant.

Among these, the riskier alternatives to prime bonds, known as the Alt-A and subprime asset classes, are circulating in a price range of low 60s to 80s, Bank of America said.

And discounts like that are enough to keep investors - especially those already knee-deep in legacy RMBS - interested.


The high point of pricing in the legacy RMBS market came in June, when BlackRock sold its first all-or-nothing auction of mostly subprime bonds.

Credit Suisse bought the US$3.7bn for more than the second-best cover bid of 73 cents, and then quickly offloaded the notes to end buyers.

A week later, the bank won a second US$4.4bn list - a mixed-bag of prime, subprime, Alt-A, home equity and adjustable-rate notes - that it sold on to several institutional investors.

More than a few structured finance investors are not fans of such big heavily circulated bid lists.

“Many times you’ll see supply creating demand with a private equity-type, multi-strategy fund coming into the non-agency RMBS market prepared to pay a premium,” said one hedge fund investor, who trades hundreds of millions in non-agency RMBS daily.

But the legacy deals are nevertheless having an impact on new RMBS products like SFR bonds and risk-sharing deals from Freddie Mac and Fannie Mae.

Choi, whose firm has not participated in the risk-sharing deals, said that was unlikely to change unless they were well compensated for taking on the risk in highly levered - and thinly sliced - mezzanine tranches.

And the volatility in floating-rate deals like the Freddie Mac STACR and Fannie Mae CAS is considerable.

Analysts at JP Morgan, for example, estimate that the riskier 7.12-year tranches will yield just 3.78% in a static rate environment if the housing market chugs along as expected.

If rates rise, however, the yield could jump to 6.26% under JP Morgan’s projections - and fall to -2.63% if the mortgage crisis repeats itself.

While that may be seen as a long shot, both risk-sharing programs were exposed to a recent bout of volatility that gave the government-backed initiative something of a black eye.

The bonds were meant to draw private capital into the US$9trn US mortgage market, while simultaneously helping the government reduce its footprint in the sector.

But when non-rated tranches suddenly widened from tights of one-month Libor plus 240bp to 400bp and higher in mid-August, some levered-up hedge funds that were heavily invested in the sector were served with margin calls.

Meanwhile the legacy non-agency RMBS have barely been affected by the most recent sell-off in riskier credits.

“For the time being, I’ve accepted that non-agency RMBS will grind tighter,” a second hedge fund investor said. “It hardly sold off at all during the high-yield.”


A drift in pricing, meanwhile, hit single-family rental bonds, which are tied to monthly payments on homes that institutional buyers picked up at bargains to revamp as rentals.

The inaugural US$342m American Residential Properties Inc trade, ARP 2014-SFR1, offered spreads in a band of one-month Libor +110bp-475bp when it priced in mid-August.

Those levels were 150bp wider on the riskiest F tranche than tights seen from American Homes 4 Rent’s debut print in May, according to IFR data.

In terms of yield, the initial pricing of American Residential’s US$184.7m Triple A class offered 1.258%, while only the thin US$24.4m NR/BBB- slice offered a yield above 5%, according to data from Trepp LLC.

Moreover, market-watchers note that the potential size of the SFR bond market is in flux. While the sector is expected to see US$8bn in bonds this year, cheap homes that could be used as collateral for future deals are becoming more scarce. (Reporting by Joy Wiltermuth and Andrew Park; Editing by Shankar Ramakrishnan and Marc Carnegie)

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