In a report released today, Barclays Capital analysts said that the potential supply the Federal Reserve's planned sales of parts of its Maiden Lane III (ML III) portfolio should keep a lid on pricing for the AJ tranches on CMBS deals.
The portfolio comprises illiquid CDOs and most of the collateral is backed by residential and commercial real estate bonds. The Fed acquired the assets via its bailout of insurer American International Group (AIG).
On April 3, the Federal Reserve Bank of New York changed its investment objective for ML III, allowing it to explore the sale of some of the securities.
The New York Fed’s Web site now lists the investment objective as to “repay the New York Fed’s senior loan (including principal and interest),” which funded the takeover of the assets, “followed by AIG’s equity interest (including accumulated preferred distributions representing interest) for as long as the United States Treasury maintains an economic stake in AIG on behalf of the United States taxpayer.” Please see ASR's coverage on the topic.
Barclays analysts said in the report that the shadow of potential supply from ML III is still "a drag" on the CMBS sector, particularly on AJ tranches that are still 10-15 points below their March highs.
They said that buyer interest is centered on the sale of the A-1 tranches off the MAX 2007-1/2008-1 CRE CDOs, which combined hold $2.6 billion of AMs, $2.8 billion of AJs and $1.7 billion of duper tranches from the 05-07 vintage, Barclays analysts stated.
Analysts said that there are some indications that the trades can happen in the coming month. Bloomberg had reported that Credit Suisse, Barclays, Deutsche Bank and even Goldman Sachs were readying bids on the CDO to submit to the New York Federal Reserve. For ASR's coverage of the story, please click here.
However, Barclays analysts said that if weaker market conditions remain unchanged, there is some chance of the sale being postponed given the NY Fed's investment objective to avoid market disruption.
"We saw a similar situation play out with Maiden Lane II sales last year in the non-agency space," Barclays analysts wrote. "If a sale does go through, the buyer would have two options: either to keep the current CDO structure intact, or look to buy out the remainder of the structure and collapse the deal – thereby releasing the underlying securities to be sold."
They said that apart from the A-1 tranche in the Maiden Lane III portfolio, the MAX CDO also has another $400 million of mezz tranches as well as a balance guaranteed fixed-floating swap worth roughly $6.6 billion in notional, both of which might have to be terminated or bought out prior to the structure unwinding.
If a collapse of the structure and subsequent release of the underlying occurs, analysts asked what the effect of the added supply on the market would be? They cited that customers sold about $3.2 billion in notional on a weekly basis this year. This is based on available TRACE data.
Breaking this down further, analysts estimated that in the past two months, the CMBS market saw weekly supply of roughly $1.1 billion of dupers, $400 million in AMs and $250 million in AJs. The markets were mostly able to absorb this supply given that spreads rallied strongly through much of this time period, analysts stated.
With these numbers, analysts are not really concerned regarding the $1.7 billion in potential duper supply if the MAX CDO unwinds. On AM tranches, the potential release of $2.6 billion in notional is almost like a month and a half of supply. However, in terms of the 12% enhanced AJ bonds an added $2.7 billion is equal to close to three months of supply at the near-term run rate of $250 million a week, analysts said. If the CDO's buyer actuall unwinds the structure, Barclays thinks that this shadow supply will keep a lid on AJ prices in the near term.
The release of the underlying AMs and AJs from the MAX CDOs would also mean a considerable increase in the outstanding market float. In the 2005-07 vintages, analysts projected that there is close to $153 billion in outstanding notional for duper classes, another $40 billion in AMs and $35 billion in AJs.
They said that a big portion of this is in the balance sheets of buy-and-hold accounts. Basing their thoughts on publicly available data from Schedule Ds and quarterly reports, they projected that insurers, money managers and some banks held about $97 billion of dupers, $19 billion of AMs and roughly $12 billion of AJs.
They said that these are accounts with historically low turnover rates. Aside from these accounts, an added large chunk of the bonds is kept off the market via resecuritizations either through re-remics or CDOs.
Counting the MAX CDO, analysts projected roughly $10 billion of A4s, $8 billion of AMs and $10 billion of AJs outstanding notionals are now within these vehicles. Given this, they projected that weekly trading volumes are mostly centered on the remaining notional. These are not in either of these two buckets – amounting to around $12-13 billion each in AMs and AJs. An added release of $2-3 billion in these sectors would thus mean a considerable rise in the volume of actively traded bond, analysts said.