The ABS market was a lot kinder toward the subprime MBS sector last week. Perhaps it sprang from indications that, for the first time, agency buy-side participants bought subprime MBS bonds with ratings expected to be below triple-A.
That's right - the GSEs have at last been lured out of their penthouse berths for the promise of more yield on choice securities in less desirable neighborhoods.
The $740 million Merrill Lynch First Franklin Mortgage Loan Trust, 2007-3 that priced on May 18 appears to be the lucky deal that received such attention last week, as evidenced by the deal's M1 through M4 tranche structure and the presence of M11, M12, M21 and M22 classes.
Such a landmark occurrence might be seen as giving the subprime MBS sector a huge vote of confidence, according to one market observer, especially now as the business seems to be stabilizing after a meltdown that started last February.
Merrill Lynch would not comment on the situation, but market sources said that FFMER, as the transaction is commonly known, likely pulled in agency interest because of past performance in First Franklin trusts and the fact that Merrill Lynch originated the loans.
"The [FFMER] 07-3 has got something unique going on," said another market participant. "There is no way to tell if the assets are conforming or nonconforming, but this is very interesting, given where we are in the subprime credit cycle."
Not everyone celebrated the development. Agencies, as a general rule, are supposed to be the epitome of reliability and good intentions in the ABS market, as one buy-sider put it. No doubt, this puts another wrinkle in the agencies' freshly starched reputation, by casting them as unwanted competition in new territory.
"There is already a food fight going on for bonds in the high-grade A's'," he said.
Perhaps this buy-sider is right. Maybe the agencies should not begin to snap up lower-rated securities with greater promises of yield, especially when they play such a critical role in funding the mortgage market. Not to mention the fact that other investors are still working hard to exploit the remnants of a wider spread environment from several weeks ago.
"I cannot think of a time when that happened," said one seasoned trader of the FFMER deal. "For one of the agencies to buy below AAA' is not the norm. Now, I don't know if that will cause a wholesale [market] change, but it is an interesting point."
Otherwise, mortgage-related securities dominated pricing. Buy-side participants, whether they are CDO managers buying significant chunks of securities or traditional and cautious investors, are interested in the subordinate levels of all transactions.
Several market participants say this is owing to improved technical dynamics, which always makes for a better market. A couple of other deals cashed in on that sentiment, including the eponymous, $487 million Bear Stearns ABS 2007-SD3. That transaction priced its triple-A rated, 2.67-year tranche at 25 basis points over the one-month Libor, while some yield tightening was evident in the 5.1-year, single-A2 tranche. That class promised to yield 200 basis points over the same benchmark.
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