By the Numbers
Parsing market signals in the latest agency credit risk transfer
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
If the market reception for the most recent agency credit risk transfer deal is any sign, the appetite for exposure to the consumer balance sheet is strong. The latest Freddie Mac deal involved some of the largest blocks of subordinate credit risk ever traded, attracted heavy investor demand and ended up trading at tighter spreads than initial talk. The deal was helped by a few tweaks to the CRT structure that drew in new investors and by optimism about the future of CRT under the new leadership at the Federal Housing Finance Agency.
Freddie Mac’s STACR 2021-DNA5 priced on July 19 and transferred risk on $71.39 billion of loans largely originated in November and December last year. Outside of STACR 2019-FTR3, which combined four other STACR deals, the 2021-DNA5 deal referenced the largest pool of risk ever transferred in program history. The deal also placed $1.186 billion of securities, including the largest B1 and B2 classes ever sold.
Despite its size, investor demand left most classes of the 2021-DNA5 transaction oversubscribed, with some classes oversubscribed by nearly 10 times. Spreads tightened from price talk across the structure, with the B1 class seeing the most. Talk on the B1 started at SOFR + 325-350 bp and ended with the class pricing at SOFR + 305 bp. Even then, the tranche was still more than six times oversubscribed. The M2 class started at SOFR + 175-185 bp but ultimately priced at SOFR + 165 bp and was nearly 10 times oversubscribed.
Beyond the strong bid, demand was broad. The deal drew 66 unique investors, according to Freddie Mac, the most in a STACR transaction since 2017. The B1 class alone drew 39 unique investors, the most for that class in a STACR deal ever.
A few structural changes and better ratings likely provided a substantial lift to investor demand. Freddie Mac sets a minimum credit enhancement required before the M1 class can get principal. This is often set above the point where the M1 detaches, requiring the reference pool to pay down before the M1 gets principal. In 2021-DNA5, the agency reduced the minimum credit enhancement threshold to the 2.0% detachment point on the M1 class, making the class open-pay at issuance and substantially shortening the weighted average life on sequential-pay M2 and B1 certificates. The M2 class ended up not only shorter, but carried an investment grade rating at issuance, which likely fueled greater investor demand. The B1 class was notched just below investment grade and, importantly, was ERISA eligible, potentially increasing demand for that bond as well.
Investors also arguably showed new optimism about the future of CRT. The prospects for future issuance dimmed under existing GSE capital rules put in place under former FHFA Director Mark Calabria. Those rules diluted the capital benefits associated with issuing CRT by roughly 50% compared to capital rules proposed in 2018. Under new FHFA leadership, one potential path that could drive CRT issuance higher sooner would be the possibility that FHFA could delay the implementation date of the new capital rule while the current one is under review by newly nominated leadership. There is existing comparable precedent for this as the Consumer Finance Protection Bureau delayed implementation of new Qualified Mortgage definitions and rules prior to implementation. If FHFA were able to delay implementation of the capital rules, the GSEs would likely revert to the Conservatorship Capital Framework in the interim. An adoption of the CCF would likely pave the way for increased CRT issuance sooner than would otherwise happen under a completely revised capital rule. And while newly appointed leadership at FHFA has not made any public statement with regards to their views on the value associated with the enterprises issuing CRT, its highly likely that they will have a more constructive view of the programs than former Director Calabria who was a public detractor of CRT. While not published by the former director, FHFA issued a report in May which offered a less than constructive view of the programs, calling into question the value of premiums paid versus losses covered by issuance along with a few other factors.
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