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Government Support for GSE Mortgage-Transfer Securities 'Unrealistic'

blogs.barrons.com | July 6, 2014

By Michael Aneiro

My Current Yield column in this week’s Barron’s magazine discusses how agency mortgage-backed securities – those underwritten by GSEs like Fannie Mae (FNMA) and Freddie Mac (FMCC) – look rich, and yield-hungry investors are turning to non-agency MBS and other, newer types of bonds called risk transfer securities. From my column:

Since last year, Freddie Mac has offered a handful of bonds under a new program called Structured Agency Credit Risk, while Fannie Mae has offered three bonds under a similar program [called Connecticut Avenue Securities]. The basic idea is to slice up the credit risk of underlying mortgage bonds and share it with investors at different levels.

“The liquidity and depth of the GSE market is second only to Treasuries, and this is one way to keep the market as it is and transfer some of the risk to the private market,” says [Fidelity's Bill] Irving, who observes that such alternative types of bonds “could be the future of housing finance.” Still, he’s skeptical of the current offerings. “You could easily imagine a scenario in which they get impaired,” he says.

Late last week Fitch Ratings weighed in on this market that’s so far produced seven deals worth $150 billion. Fitch believes the implicit government support enjoyed by agency MBS does not apply to these new securities:

Trading spreads in the secondary market have tightened considerably since the initial transactions were issued in mid-2013. We don’t believe this has been driven by any perceived inference of federal government support if losses arose. These deals’ lack of explicit government guarantee, coupled with the clear and strategically important intent of the Federal Housing Finance Agency (FHFA) to shrink the mortgage market’s dependence on government guarantees, makes any support of these deals unrealistic.

We detect a mix of supply-demand and other drivers behind the tighter trading levels. Existing risk sharing deals have been issued with floating rate coupons, which reduces investor duration risk. The spreads over LIBOR have been fairly attractive, but have lowered in more recent transactions as liquidity has improved. Pricing on the M1 class of the first STACR deal (issued in July 2013) was issued near par of 100, (with a coupon of LIBOR+340 bps), but had bid up to 105.46 as of trade dates reported through TRACE at the end of May.

Fitch said the FHFA “will easily meet” its goal of tripling each GSE’s risk-sharing volumes, bolstering the market’s liquidity, adding that the transparency of the transactions and underlying reference pools “adds to the market’s growing comfort level.” Here’s Fitch with a further primer:

Mortgage risk transfer securities bear several unique characteristics compared to traditional RMBS. One key difference is that these deals are structured as synthetic credit transfers, but are technically unsecured obligations of the GSEs and are consolidated on their balance sheets. This structure, which is largely driven by certain Commodities Futures Trading Commission rules, is less preferable than the more conventional credit-linked note structure, in Fitch’s view. Under the terms of the notes, a small amount of loss would be incurred by the GSE first, then the investors would fully absorb principal losses based on a predefined ‘loss severity schedule’. Above the scheduled losses, the GSEs would absorb the remaining risk.

 

Back to July 2014 Archive

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