The potential sale of the Maiden Lane III (ML III) assets might signal that the Federal Reserve is making its move to take liquidity out of the system, securitization experts said today.
The Fed might also be getting ready to raise interest rates, the experts added.
On Tuesday, the Federal Reserve Bank of New York changed its investment objective for ML III, a portfolio of mortgage-linked bonds acquired through its bailout of insurer American International Group, allowing it to explore the sale of some of the securities.
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"It wouldn't make sense for them to raise rates while still holding all of these mortgages so they sell the mortgages and they take cash out of the system," said Adam Murphy, founder and president at Empirasign, an ABS/MBS trade database.
The move could also amount to the inverse of quantitative easing. "People were expecting QE III, but this actually potentially reverses QE II. In QE I, the Fed brought money in and bought mortgages. Now it is the opposite — it's the Fed selling mortgages and taking money out of the system."
ML III comprises illiquid CDOs and most of the collateral is backed by residential and commercial real estate bonds.
TreppWire, a publication of CMBS data provider Trepp, reported today that the Fed's announcement has led to a deep sell off in the CMBS market.
Legacy super seniors saw spreads move out eight to 15 basis points on average, TreppWire said. While the better names and older vintages withstood the widening pressure, weaker names were hit hard, according to the report. The benchmark GSMS 2007-GG10 A4 bond closed yesterday at 236 basis points over swaps, which is 15 basis points wider than Tuesday's closing level.
Further down the credit curve, stronger AM paper widened by 15 or 20 basis points, but weaker names were went wide by about 50 basis points, the Trepp data showed.
"In the AJ market, paper with decent collateral sold off by a point or two, but with 'dented' AJ's, the damage was twice as much," according to Trepp's report. "The consensus was that weaker AJ's were off two to four points in price, but one trader thought the losses were even bigger."
Even the more recent vintage deals issued in the CMBS 2.0/3.0 market experienced spread widening at the top rated classes by five to 10 basis points. The double-A and single-A bonds widened by 10 to 20 basis points and triple-B bonds widened 20 to 25 basis points.
In terms of CMBS, NewOak Capital CEO Ron D'Vari believes that "the Fed action is actually not a negative on the market."
He explained that this was because the market is looking for supply at the right price. "New deals are still fairly small compared to the appetite of investors for long, high-quality assets that they can analyze and put a price and risk on," he said. "The general direction for commercial real estate is positive with improving rents and more demand for institutional assets."
He added that the big factor is improving unemployment and having a positive corporate outlook for stable growth. This view on the market must be combined with low interest rates and four years of very limited new developments.
"Of course, investors still have to be very careful to make sure the underwriting quality doesn’t suffer in the mix to do more and bigger deals. Nothing substitutes doing your own homework," D'Vari stated.
However, the fact that the Fed is selling the assets should not come as a surprise, said Walter Schmidt, manager of structured product strategies at FTN Financial in an e-mailed statement.
"I’m not surprised by the change in stance from the Fed regarding the remaining ML assets," he said. "After all, ML II sales went much better this year than last. I am a little surprised they actually changed the language on the mandate. It seemed unnecessary to me."
But the move he said doesn't necessarily mean that the Fed is looking to hike rates in the short-term or that it's looking to reverse its quantitative easing.
"We have to remember that the Fed is truly in unprecedented territory here with [zero interest rate policy or ZIRP] and quantitative easing," Schmidt said. "Even though it may have seemed haphazard at the time of implementation, it will take a LONG time to get back to whatever is 'normal'. I don’t know if I would characterize it as the Fed taking liquidity out of the system, as much as unwinding, to a very small degree, the enormous amount of liquidity they put into the system to begin with. It may seem like a small distinction, but I think it’s an important one."
