Two recent and largely unrelated developments have renewed attention to two recurring post-downturn themes that persist even though the bubble’s bursting is receding further into the rear-view mirror, namely: The potential for heightened buyback sensitivities and for covered bonds to make more inroads domestically.
As noted on our website last week, Freddie Mac warned investors about a one-time wave of buybacks hitting certain of its MBS last week. It didn’t move the overall market, but it was among continuing reminders from both government-sponsored enterprises that buyback sensitivity remains high.
As Credit Suisse managing director Mahesh Swaminathan noted in an interview last Wednesday after Freddie’s announcement, it was “not enough to trigger a market move,” but it did add “to the mix of concerns, if you will.
“This type of buyout is not unprecedented. They routinely make lenders buy out if there is a flaw,” he said, adding, “The scale of it was large enough that they had to make an announcement.”
As noted on this publication’s website earlier, it turned about to be a situation where what Bank of America said was an operational glitch led to a situation where origination of certain, mostly current loans backing the securities didn’t proceed the way it should.
After deadline for the original online story, Freddie Mac released an additional statement saying that it and B of A had mutually agreed to the repurchase because “the loans were underwritten using alternative valuation methods that were prohibited for use in the underwriting of the particular types of mortgages involved.
“What’s more, these loans were not subject to any revised loan sampling methodology.
“While the repurchase transaction was consistent with our policies regarding enforcement of lenders’ repurchase obligations, we believe the contract violations that triggered it constituted a one-time occurrence.”
One might think with all the attention to loan quality since the downturn, buyback risk might be diminishing, but no process is foolproof. Also one might think that with U.S. covered bond issuers largely absent from the market (the two predownturn domestic programs that exist seem to be in wind-down mode), all that talk about covered bonds gaining some ground in the U.S. could be considered passé.
But with the issuance of a recent SEC no-action letter that potentially widens U.S. investor access to Canada’s growing U.S.-dollar denominated covered bond issuance, as well as the growth of U.S.-dollar denominated CB programs in general, that might not be the case. It remains true that the relative constriction of what was once a wider range of mortgage-related securities products in the wake of the U.S. downturn has made U.S. dollar-denominated covered bonds relatively more attractive to certain domestic investors as an “MBS alternative.”
The no-action letter could expand U.S. interest as it “allows investors who may have been restricted from buying 144A...to participate,” said Vanessa Purwin, a senior director at Fitch. Traditionally covered bonds, which originated with Germany’s pfandbriefe, can be backed by either public sector loans or mortgages in their cover pools. But so far, “Predominantly mortgage programs have been issued into the U.S. market,” she said.
Canadian issuers in particular have been showing interest in both expanding covered bond issuance and reaching a larger investor base internationally. They have proposed a legislative framework for the bonds known to improve their attractiveness in the European market as well as issuing bonds denominated in U.S. dollars.
