Freddie Mac last week announced the lead underwriters for its inaugural Reference REMIC security offering (see ASR 4/4/05). Lehman Brothers, Morgan Stanley and UBS are the lead underwriters for Reference REMIC series R001, which is expected to have a 4.75% coupon and will be backed by two 15-year 5.0% PC pools. The initial transaction's guaranteed final maturity will be April 15,2015.
Many Street analysts welcomed the event. "The Freddie Mac Reference REMICs are a welcome addition to the market," UBS MBS analysts said. "From the mortgage market's point of view, a liquid CMO benchmark is a very good thing, as it will facilitate trading in these issues, plus it could serve as a benchmark for other CMOs."
These securities, analysts said, would be appealing to Agency debenture, asset-backed as well as foreign investors who have historically not been MBS purchasers, noting specifically the new product's Guaranteed Final Maturity feature. "The idea behind reference REMICs is to broaden the investor base for mortgage-backed securities by giving investors a way to buy mortgage cashflows while still receiving guaranteed final maturity," UBS wrote. Deutsche Bank Securities said that the new REMIC's the Guaranteed Final Maturity feature is popular and is expected to be attractive to a wide array of buyers, noting that Reference REMICs are considered a natural alternative for investors in callable agency notes.
MBS investors seem to agree that this is not a product that directly targets them. Bill Chepolis, a managing director in the fixed-income group at Deutsche Asset Management, said that they may or may not invest in Freddie Mac's new REMIC depending on how the issue is priced. He added that the first two offerings of this Reference REMIC may come a little wide as the issuer wants them to be attractive and there is limited volume with new products like this. He said that this product does not particularly cater to the typical mortgage investor who is being paid to manage duration drift but rather for cross-over investors such as those who invest in longer ABS and intermediate CMBS. The REMIC would probably price inside of mortgages, and if it was priced efficiently and liquid, could be attractive to investors who wish to make a concentrated bet on the mortgage basis, such as hedge funds. He added that Freddie Mac could do a lot with the program because it is not only a way to promote the Freddie Mac name, but it's also an efficient vehicle for the GSE to buy assets against their debt issuance.
Chepolis also said that this product could appeal to those that do not really track the traffic in the CMO market, and who are frustrated by the lack in pricing clarity in CMOs such as some financial institutions. However, he acknowledges that some of these pricing inefficiencies or nuances are actually beneficial to managers seeking to exploit MBS bets. So it depends on one's perspective. The pricing efficiency offered by the new REMIC would be more attractive to new mortgage and CMO investors rather than traditional buysiders who are paid to take duration and pricing risk. "That's why you get paid a spread over Treasurys," Chepolis said.
Bear Stearns analysts said that this new product is expected to set a new standard for transparency in the structured MBS sector, where securities are typically owned and priced by a single broker/dealer. Thus analysts said that this could be attractive to buysiders who need continuous pricing for risk management or reporting. For instance, central banks that have strict transparency requirements or money managers that have to report daily net asset values might find this new product useful.
Analysts are not certain about the REMIC's liquidity implications for the broader agency CMO market, noting that reference REMICs usually trade at tighter spreads relative to identical CMOs because of the required price transparency. The spread difference, said Bear, should represent the market price for the transparency. If the said spread proves sufficient, other dealers might have the incentives to offer intraday and closing prices on their own underwritten securities. However, analysts said that this transparency might not mean liquidity as investor ability to sell in size at the posted spreads is yet to be seen.
Bear Stearns added that the new product's implications for mortgage spreads remains uncertain as Freddie already owns the collateral that is going into the new REMICs, so this does not necessarily mean fresh demand. But if the GSE chooses to use the proceeds from the Reference REMIC to buy MBS, this would be positive for MBS spreads. However, analysts said that if Freddie opts to buy back more expensive debt instead, then this is neutral for spreads.
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