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Investor interest in the agencies' new credit-linked risk sharing securities is growing. Image: Fotolia
Investor interest in the agencies' new credit-linked risk sharing securities is growing. Image: Fotolia

Fannie, Freddie Risk-Sharing Bonds Defy Skeptics

MAR 6, 2014 4:25pm ET
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The recent investor reception to Fannie Mae and Freddie Mac's risk-sharing securities addresses an initial, key concern about them last year—whether they would draw enough buyers.

More than 65 investors participated in a Freddie Mac transaction in February. The oversubscribed offering of credit protection on a $31 billion reference pool of mortgages was the third Structured Agency Credit Risk transaction the government-sponsored enterprise has offered since their inception last year. Similar Fannie Mae deals, known as Connecticut Avenue Securities transactions, also have done well, analysts say. Fannie has issued two of these, one last year and one this year.

"From all indications spreads have done very well. Investor participation has increased over time and the sizes [of deals] are getting to be more substantial," says Mahesh Swaminthan, managing director and head of mortgage-backed securities strategy at Credit Suisse, New York.

Spreads between the floating-rate securities and the one-month London Interbank Offered Rate widened slightly late last year. But this was a normal, seasonal occurrence and the securities are back on track now, analysts say.

"Fannie and Freddie each successfully launched deals this year, and spreads are coming back a little on the tighter side as we get into 2014. It's not too much of a surprise. We have a 'January effect' every year in the structured market," says Walter Schmidt, a senior vice president and the manager of mortgage strategies at FTN Capital Markets in Chicago.

Indeed, in secondary trading, the spread on the M-1 tranche, the highest-rated one in Freddie's previous STACR deal offered to investors, has tightened roughly 10 basis points, market sources say. 

The lowest-risk investment-grade class of Freddie's deal offered to private investors in February sold for roughly 100 basis points over one-month LIBOR. The next riskiest invest-grade tranche offered to private investors sold for 220 basis points over that benchmark, and the riskiest, unrated tranche offered to private investors sold for 450 basis points over one-month LIBOR.

(The most recent rated M-1 tranche's pricing cannot fairly be compared to the top rated tranche of the previous deal because of differences in how the deals were structured and the ratings received.)

Government officials had a lot of questions about whether private capital would step up to buy agency risk-sharing transactions when they were first considering proposals for them, Mortgage Bankers Association Dave Stevens said last year. He said then he was confident that there would be.

Adding ratings to the newer offerings has helped draw in buyers.

The earlier, unrated deals had to pay an extra risk premium, says Marc Firestein, nonagency MBS strategist at Credit Suisse in New York.

"The spreads off of the first deal were significantly wider because in the first iteration of it, the concern that was raised was whether it would be truly programmatic and whether the bonds would end up in sort of an orphan status," he says.

But as more bonds came to market and got the incremental benefit of rating agencies rating the top tier notes, buyer interest has ramped up, says Firestein.

The risk-sharing deals are filling a vacuum in the market that has developed with new private-label MBS issuance so sparse since the financial crisis, says Schmidt. At least two new private-label MBS deals have come to market this year, one issued by Credit Suisse, and the other by JPMorgan.

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