When Congress lifted the conforming loan limit in certain high-cost housing markets, it provided some much-needed liquidity for homebuyers.
But it also created a dilemma for Fannie Mae and Freddie Mac.
The government-sponsored enterprises are tasked by their regulator, the Federal Housing Finance Agency, with offloading the credit risk of mortgages that they purchase. Yet there are limits to the amount of “super conforming” loans that they can bundle into standard mortgage-backed securities. That left a large number of loans sitting on their books, ultimately putting taxpayers at risk for losses.
Freddie Mac’s solution was to come up with a new kind of transaction in which it securitizes super conforming mortgage and offloads the first risk of loss on the loans at the same time.
The company is currently marketing the third such deal: The $350 million Freddie Mac Whole Loan Securities Trust, Series 2016-SC01 is backed by two pools of fixed-rate, first lien, super conforming mortgages acquired from multiple sellers between August 2015 and May 2016.
Bank of America Merrill Lynch, Barclays, Wells Fargo, Nomura Securities, and Loop Capital are the underwriters.
The two senior tranches of notes to be issued by the securitization trust, representing 94% of assets, are guaranteed by Freddie Mac and are unrated. There are also two mezzanine tranches, rated Baa1 and Baa2 by Moody’s Investors Service, that are not guaranteed and so transfer credit risk to investors. The trust will also issue an unrated B tranche that will bear the risk of the first 1% of loss.
All of the notes have a legal final maturity of July 2045.
This is very different than the way Freddie Mac securitizes regular conforming loans, bundling them into mortgage bonds that are fully guaranteed. It then offloads the credit risk via various kinds of transactions including credit-linked notes and reinsurance policies.
Whole Loan Securities Trust transactions are more similar to K-Deals, in which Freddie Mac securitizes commercial loans that it acquires. K-Deals also issue senior tranches of notes guaranteed by the GSE and subordinate notes that are not guaranteed.
(In addition to guaranteeing the senior certificates, Freddie Mac will initially retain a 5% vertical slice of the initial balance of each of the subordinate certificates, aligning its interests with those of investors.)
Freddie has completed two prior whole loan deals, both in 2015; the first was for $300 million and the second for $600 million.
The risk profile of the latest deal is similar to those of the first two deals, according to Moody’s. The 661 borrowers have high FICO scores and sizeable equity in their properties. The weighted average FICO score for pool 1 and pool 2 loans is 759 and 738, respectively.
However, the weighted average loan-to-value ratio and debt-to-income ratio are both higher than Freddie’s second deal. It also has a higher percentage of large loans, which can results in additional risk at the tail of the transaction, when few loans remain. At that time, the default of a few large loans could reduce enhancement significantly and result in losses to the subordinate bonds.
On the plus side, the loans backing the latest deal are more seasoned and less geographically concentrated.
Fannie Mae takes a different approach: Super conforming mortgages in excess of what can be bundled into standard mortgage-backed securities are bundled into bonds backed exclusively by super conforming loans. But Fannie Mae guarantees all of the tranches issued by such deals. It offloads the credit risk via its flagship risk-sharing programs, Connecticut Avenue Securities and Credit Insurance Risk Sharing.