After four successful credit risk transfer STACR deals during the past nine months, Freddie Mac is now looking to expand this programme to pools of riskier loans on its books.
“We will continue to expand STACR to greater than 80% LTV mortgages,” Kevin Palmer, vice-president of strategic credit costing and structuring at the government-sponsored enterprise (GSE), tells Euromoney. “We will continue the STACR debt note series for 60% to 80% LTV and we will introduce a new STACR debt note series for 80% to 95% LTV mortgages.”
Freddie Mac is hoping to tap into investor appetite for credit to push credit risk transfer across a broader range of loans it has on its books.
So far, the STACR programme has been squarely focused on the highest-quality, lowest-risk 30-year fixed-rate mortgages, which make up the bulk of loans on its books. Thirty-year fixed-rate mortgages with LTVs of between 60% and 95% make up 75% of new fundings – excluding home affordable refinance programme loans.
However, given the reception the credit risk programme has had, it is not surprising that Freddie Mac is looking to push the boundaries even further. “Will also look at doing ARMs and higher-LTV 15-year loans in future,” Palmer confirms. “But for the time being we have got a good mousetrap that is working well.”
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| Kevin Palmer, vice-president of strategic credit costing and structuring, Freddie Mac |
The first STACR deal took place in July, a $500 million two-tranche unrated deal structured by Credit Suisse. The second, a $630 million trade in November through Barclays, saw the senior tranche rated triple-B and the junior tranche remain unrated. Earlier this year, Freddie Mac issued its third STACR trade, a $1 billion deal split into three tranches, two of which were rated by Kroll. At the end of March, Morgan Stanley and Nomura led the fourth STACR deal, an $966 million deal again in three tranches, one rated single-A and one rated
triple-B.
With Freddie Mac and Fannie Mae – which runs its own credit risk transfer programme, Connecticut Avenue Securities (CAS) – now issuing quarterly, investor acceptance of and appetite for these deals has sharply improved.
Any concerns over the future of the GSEs have been allayed by the fact STACR debt ranks pari passu with the $500 billion of Freddie Mac outstanding and investors would not be subordinated to other debt holders.
“Continued supply into the risk-transfer space has seemingly improved the already strong technical forces that have been driving bond performance,” notes Chris Flanagan, head of US mortgages and structured finance research at BAML in New York.
“Spreads on the unrated tranches of the first issued CAS and STACR deals are now 100 basis points to 120bp tighter on the year, while the triple-B tranches have come in 70bp to 90bp. Over this period, paper began to shift from fast-money accounts over to real-money clients which have not seemed to as aggressively look to take profits despite the significant tightening.”
This is a trend Freddie Mac clearly wants to take advantage of. “The market is pretty good in structured credit at the moment – it feels like there is insatiable appetite right now,” says Palmer.
“We are thinking from a very long-term programmatic perspective, but we do wish that we had all these products ready to go now – we would be doing monthly transactions if we could.”
Given that the first STACR deal involved the release of 13 years’ worth of data – and that any potential ARMs deal would involve a similar level of transparency – that is, however, unlikely to be happening any time soon.
As the mortgages backing the STACR deals become less homogenous, levels of risk transfer could be set to rise. The first STACR deal saw 3% of the risk of the credit risk on the mortgage pool transferred, and the fourth 4.5%.
The latest deal, which involved a pool of 116,000 residential loans with an unpaid principal balance of approximately $28.5 billion, was [stress tested] for a housing market downturn of 25%, which would have triggered 3% of losses. The additional 1.5% was added to the risk transfer level as a cushion.
Higher risk loans would likely necessitate higher risk transfer, but deals involving new asset types will be structured on a case-by-case basis.
“We would likely need to take a different approach with ARMs, which can be done through the capital structuring,” says Palmer. “The key thing will be the reset period of five or seven years.
“We won’t set any defined ceiling for credit risk transfer. If the risk transfer justifies it, we will do it, but I don’t see the level going above 10%. Fifteen-year loans are a very clean asset, so risk transfer on such deals might even be lower than 4.5%.”
Given the inevitability of further Fed tapering, Palmer is acutely aware of the need to diversify Freddie Mac’s credit risk transfer programme, and is focused on exploring additional reinsurance options after the deal that was inked with Arch Capital Group in November.
That deal saw the GSE buy cover for roughly $77 million of losses on a pool of 96,000 mortgages with an outstanding balance of $22.5 billion. Fannie Mae had bought reinsurance cover on a $5 billion pool of mortgages from National Mortgage Insurance Corp the month before.
“There has been a lot of focus on STACR and CAS, but we are also trying to build out traditional tools,” Palmer explains. “We want to further expand the reinsurance offering this year and develop a strong reinsurance vehicle to transfer risk to the global reinsurance market.”
The aim is to grow and develop both credit risk transfer options in tandem to mitigate any impact from a potential change in credit risk appetite as the Fed’s extraordinary measures wind down.
“Having both levers available is good,” says Palmer. “We are able to have good access to both markets.
“The big advantage with STACR is that it is fully funded and there is no counterparty risk. But the insurance company product generally offers more consistent pricing because pricing is based on fundamentals not market technicals. We have seen very competitive pricing on the insurance side.”
