Freddie Mac’s next STACR offering will offer investors exposure to actual losses on residential mortgages, something the mortgage giant says investors have been asking for.

Structured agency credit risk notes act as a kind of reinsurance: they are general obligations of the Freddie Mac, but the mortgage giant can hold on to interest or principal if losses on a reference pool of mortgages reach a predetermined level. All previous offerings measured these losses using a “fixed severity” approach. Essentially, investors took a hit once loans were delinquent for more than 180 days. Loans six months behind on payments are assumed to be headed for default and a portion of the principal of these loans is repaid. The portion of the principal repaid is determined by the typical loss severity on loans in the reference pool.

(There are exceptions to the 180-day rule for delinquencies related to natural disasters and certain other events).

Exposing investors to actual losses could make STACR notes perform more like private-label residential mortgage backed securities. Potentially, losses could be less severe, since some loans that fall six months behind on payments are eventually cured. However it’s not yet clear how delinquencies would affect the timing of cash flows. In a private-label RMBS, the servicer will advance the missed interest payments for a period of time if the loan is assumed to be recoverable.

Market participants say that neither Freddie nor the deal’s underwriters, Credit Suisse and Citigroup, have spelled out the timing of cash flows under various scenarios. It is likely that the agency is waiting for feedback from investors.

In the meantime, Freddie has updated a database that it publishes on approximately 17 million, 30-year, fixed-rate single-family mortgages originated between January 1, 1999, and June 30, 2013 to provide certain data points on actual losses.

In other respects, the next STACR will be structured similarly to previous deals. Freddie Mac will continue to sell tranches taking the first loss when borrowers miss payments as well as the mezzanine tranches, while retaining a vertical slice of each tranche sold.

Credit Suisse will act as the structuring lead manager, with Citigroup as a co-lead manager and joint bookrunner.

"We think the market of the future, where increasing amounts of credit risk will be transferred to private investors, will be actual loss based and we are excited to begin that transition with the next STACR offering," Mike Reynolds, Freddie’s vice president of credit risk transfer, said in a press release.

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