In a relatively new development in the agency sector, Freddie Mac has come to market with a CMO backed by 7/1 Agency hybrids. Street analysts say that although using hybrid ARM collateral for CMOs is common in the non-agency arena, this may be the first agency hybrid deal.
Aside from this, through structural innovation, the transaction was also geared towards ABS investors, as well as targeting traditional ARM investors.
The transaction, called Freddie Mac Structured Pass Through Certificates Series T53 (FSPC T53), consisted of $655 million of offered securities, though the total deal was larger. The transaction closed on Nov. 7. Co-lead managers were RBS Greenwich Capital and UBS Warburg while the co-managers were Goldman Sachs, Credit Suisse First Boston and Bear Stearns.
The transaction was structured in four tranches: AI through AIV. The first two were offered to more traditional ABS investors and the next two were offered to the more traditional ARM investors. The deal was sequentially tranched between a .5 year, a 1.25 year , a 2.0 year, a 3.75 year, which divided up the first 56 months of the cashflow.
Targeting ABS buyers
Certain hurdles had to be overcome in structuring the transaction. First, there was the investor base. Typically, there has not been a natural buyer for agency hybrid ARM product because it remains fixed for so long. This makes it difficult for traditional or floating rate investors to get into it. Additionally, since there is a reset date on ARM product, it is harder to tranche out this type of collateral sequentially compared to other fixed-rate product.
The solution was to have Freddie Mac effectively guarantee the tail end of the transaction. In other words, the Agency would be purchasing the tail cashflows and the IO on the deal. The fixed-rate pieces were tranched out and the Agency put legal finals on the classes to make them relatively short.
The key innovation in this deal was that it targeted asset-backed investors, so it has actually helped broaden the investor base for agency ARM product. Previously, with only the longer pieces to sell, it only attracted straight ARM investors. By making the product look and feel more like ABS - with tighter principal and shorter legal finals - Freddie was able to access crossover investor base while still retaining some of the traditional ARM buyers.
One of the things that ABS investors are very conscious of when buying mortgage product is the increased convexity risk inherent in the collateral. This particular investor concern was addressed by putting shorter maturities on the agency ARM collateral that backed this deal.
Meanwhile, there was some speculation on the Street as to why Freddie did the transaction.
"It seems to be driven by Freddie wanting to retain the IO and the long piece," said a senior mortgage analyst. "There is plenty of demand for all kinds of short stuff out there. When you do a CMO it is kind of easy to sell the short stuff and harder to sell the long stuff. By buying the long piece in this deal, Freddie does not have to sell the long cashflows and I think that is what drove the deal."
Other observers explained that the demand for stable, short fixed rate assets remains strong, especially for banks and depositories that have had to deal with enormous levels of portfolio runoff. The short legal final on the bonds is an added sweetener-it meets demand that is normally met by balloons and VADMs, neither of which is in abundant supply.
Freddie Mac declined to comment on the deal.