Saturday, 21 April 2018

Index in works to normalize exotic mortgage bond deals

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Fannie Mae is looking to create a new benchmark index to help bring some of its more exotic mortgage bonds into the mainstream.

The index would track the so-called credit risk transfer sector, which was started more than three years ago to reduce taxpayers’ exposure to Fannie and Freddie Mac’s bulging home loans portfolios.

“Some investors have expressed interest in a total-return index,” Robert Ives, vice president of retained portfolio asset management at Fannie Mae, told IFR.

Potential candidates could be banks that already house other fixed-income benchmark indices or those that already arrange, sell and provide pricing on credit-risk transfer bonds.

Its main purpose would be to give investors a way to gauge their performance against the benchmark index, and to market the sector, Ives said.

“There could be some one-off trades tied to this, but it is not the objective,” he said.

That contrasts with bond startup Vista Capital Partners’ efforts to build an index and give investors the option to hedge or short credit-risk transfer bonds.

Vista has been chipping away at its strategy for around two years, but adding potentially risk-amplifying derivatives to the mix has made progress slow going.

The benchmark index proposal, however, has a broader aim of making an already complex asset class more ordinary.

“You can reference a dealer report, but it doesn’t have the staying power or import of a benchmark index that you can put in marketing materials,” said Michael Canter, the head of securitized assets at AllianceBernstein.

“It helps to normalize the market.”

Ideally, both Freddie and Fannie bond deals would be included in the index, said a mortgage professional at a major bank who has met with both agencies about the strategy.

“There definitely is a need for it,” the mortgage professional said.

Freddie declined to comment.



Credit-risk transfer bonds, like other Freddie and Fannie mortgage bonds, are tied to home loans originated under stricter lending standards put in place after the housing crash.

But unlike the bulk of today’s mortgage bonds that are issued with government guarantees, investors in credit-risk transfer notes run the risk of taking on losses if mortgages backing a bond deal sour.

Last year buyers were deeply compensated for taking up such bonds, particularly on riskier classes that carry low to no credit ratings.

Double B, Single B and unrated CRT bonds topped the mortgage bond charts last year with returns of 10%-18%, according to JP Morgan data.

And in the policy world, the notes have come to represent a significant buffer between taxpayers and mortgage losses as political gridlock remains around ending Freddie and Fannie’s more than eight years in government conservatorship.

“I think credit-risk transfer today has been highly sucessful,” said Mark Zandi, chief economist at Moody’s Analytics, at a recent Goldman Sachs housing conference.

“[It’s] three years in and there is a lot of room to expand.”

About 23% of Fannie Mae’s near US$2trn portfolio of guaranteed single family mortgages had been included in credit-risk transfer transactions as of December 31, according to public filings.

Freddie included about 34% of its US$1.76trn portfolio during the same period.



But despite their growing popularity, credit risk transfer bonds are still difficult to buy in size outside of primary market offerings.

Dealers are required to hold at least a dollar in capital against each dollar of CRT risk on their books under new capital rules put in place after the mortgage meltdown, making for a challenging secondary trading environment.

The hope is that a benchmark index would help bring the sector more into the mainstream where bonds can trade between parties more frequently.

“There has to be a way to help with liquidity, otherwise it’s not as salient as an asset class as it could be,” said John Kerschner, global head of securitized products at Janus Capital Group.

“Right now it’s hard to buy the sector in size, unless you buy new issue and hold onto it.”


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