Fitch: GSE Risk Transfer Deals Fill Void for US Mortgage Paper
NEW YORK--(BUSINESS WIRE)--Tight pricing on mortgage risk transfer securities issued by Fannie Mae and Freddie Mac indicates a growing appetite for this relatively new and unique form of mortgage risk, says Fitch Ratings. The securities are among the few alternatives available for residential mortgage-backed investing apart from fully agency backed deals.
The risk sharing deals - called Structured Agency Credit Risk (STACR) Debt Notes (issued by Freddie Mac) and Connecticut Avenue Securities (issued by Fannie Mae) - span a total of seven deals referencing over $150 billion of mortgage risk thus far, with deal volume expected to grow.
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.
Furthermore, the FHFA outlined in its most recent strategic plan a goal of tripling each GSE's risk sharing volumes over 2013 levels. Based on recent issuance, we expect GSEs will easily meet these goals. Thus, expectations that the GSEs will supply a steady stream of deals will continue to bolster liquidity in the secondary market, which also helps explain the price tightening.
The level of transparency associated with the transactions (including TRACE reporting) and underlying reference pools adds to the market's growing comfort level.
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.
Private label RMBS issuance has shown some signs of life in 2014, but volumes remain a fraction of pre-crisis levels. Five deals had been issued through last week, totaling $1.6 billion of par. Well under 1% of overall mortgage origination volume is currently being securitized in non-agency backed deals.
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