The Maiden Lane and Sequoia transactions may not herald the return of a vibrant RMBS market anytime soon, but they do indicate significant demand for bonds at nearly opposite ends of the RMBS market.
On Jan. 19, the New York Federal Reserve Bank sold RMBS from its Maiden Lane II portfolio that contains subprime and Alt-A RMBS purchased from AIG's subsidiaries as a part of the insurer's government bailout. A day later, Redwood Trust successfully completed its fourth Sequoia transaction, which securitizes "pristine" Jumbo loans made mostly to affluent borrowers.
In both cases, the deals went smoothly and found significant investor demand. The Maiden Lane sale originated with a reverse inquiry by Goldman Sachs, but the Fed's commitment last year to sell assets in a competitive bidding process prompted the regulator to seek additional bids.
Credit Suisse, Barclays Capital and Merrill Lynch also submitted bids. Credit Suisse won the beauty contest with prices for RMBS in the portfolio ranging from 43 cents to 45 cents on the dollar, according to a source whose firm had signed the nondisclsoure agreement required by the underwriter. That firm, however, did not purchase any of the securities because it had lined up with Barclays' bid, which the source said placed second.
"Not only did the bank that did the reverse inquiry have interest from customers, but at least two of the other dealers participating in the bidding contest had even greater demand from their customers," said the source from a money manager.
He added that on the same day there were 80% as many sales as buys in the RMBS secondary market, with most of those transactions likely stemming from the Maiden Lane deal. That suggests Credit Suisse quickly turned around most of the securities it had underwritten, another sign of demand.
"If Credit Suisse had bought the portfolio by itself and hadn't sold it, it still would have been a positive sign. But in this case it had customers lined up," the executive said.
"It was definitely a good sign that buyers are out there for these bonds. I think the market is pretty encouraged about that," said John Anzalone, head of structured securities portfolio management at Invesco. "They sold several billion dollars of these bonds and prices have remained stable. The market's certainly not in a position where we could handle list after list [of bonds], but it's a good sign."
Credit Suisse declined to provide details about pricing and the make up of the bonds sold but the Fed is slated to provide that information in April. Another market source confirmed the price range of 43 cents to 45 cents, while yet another source, whose firm had not purchased any of the securities, repeated market talk of prices in the mid-30s range.
In any case, secondary market pricing held steady in the days after the transaction, another sign indicating market demand. That was not true last spring when the Fed pursued a series of Maiden Lane auctions in short succession that started strong and petered out toward the end, largely because the market couldn't handle the level supply that was also arriving from distressed European banks and other sources. In fact, RMBS prices did dip after the Fed announced that it would entertain bids from four dealers, but they returned to their former levels after it became clear the transaction was initially prompted by reverse inquiry, and the Fed was not again planning to repeatedly sell lists of securities.
Anzalone noted that given the noninvestment-grade nature of the Maiden Lane ABS, most institutional investors' guidelines prohibit them from investing in it or restrict those investments to very small buckets.
"There's a fairly finite investor group for these types of bonds. It ends up being mostly hedge funds and funds designed to invest in distressed mortgage paper, with some [real estate investment trusts] and banks as well," Anzalone said.
Walter Schmidt, senior vice president and manager of structured products strategies at FTN Financial, said the recent Maiden Lane deal indicates that there are investors seeking to take advantage of the perceived underperformance of the RMBS sector.
A lot of that participation over the last few years, especially with the larger transactions, he said, has been from hedge funds looking to flip the assets for short term gains.
"In the situations we've seen, hedge funds might hold on to the assets for days, weeks or even months, but they're typically not long-term investors," Schmidt said. "If it comes to light that insurance companies and other investors with longer-term horizons participated in the sale, that gives more confidence that prices they reached are more stable."
An institutional investor cited the relatively wide bid/ask spread on most lower priced RMBS and their lack of liquidity as signs that investors with longer-term horizons likely participated in the recent Maiden Lane deal.
"You really have to be sure you're right about the price and you're willing to hold onto the securities," he said. "If you buy a big position, it's probably not going to be easy to get out of."
Mill Valley, CA-headquartered Redwood Trust priced its fourth Sequoia Mortgage Trust deal a day later, on Jan. 20. Credit Suisse was the sole bookrunner and a joint lead along with Wells Fargo on the $406 million deal, and J.P. Morgan acted as co-manager.
A $180 million, 'AAA'-rated tranche priced at 190 basis points over the swap curve, following price talk that was 10 basis points to 20 basis points higher, and a $202 million tranche with the same rating priced at 230-basis-points over the swap curve, below the 240 basis point to 250-basis-point guidance. The deal was reportedly nearly twice oversubscribed.
Redwood has been the only non-agency RMBS issuer over the last few years, issuing two deals last year and one the year before.
One institutional investor noted that its size, nearly twice as big as previous deals, was a positive sign, although investors are clamoring for bonds with such high credit quality that offer a relatively rich spread.
He pointed to the underlying Jumbo loans high loan-to-value ratio in the mid-60s, borrowers' average FICO scores of 770, and the deals 8.25% credit enhancement, adding that even if such high-quality transactions had been created back in the housing boom, their credit enhancement would have been less than half that level.
"For us, the bigger issue is probably prepayment risk. These are high end borrowers, which tend to be quicker to refinance," he said, adding that even with rates at historic lows, factors such as the Federal Reserve announcing more quantitative easing could send them lower still.
Sources noted that investor demand for RMBS assets could prompt more reverse inquiries into buying Maiden Lane assets. And at least one other REIT- Two Harbors Investment Corp. -has discussed pursuing deals similar to Redwood's, although the very high quality mortgages underlying such RMBS are hard to come by, since banks originating the loans now prefer to retain them on their books.
There was little confidence, however, that the deals hinted at a more vibrant RMBS market around the corner.
"These two [transactions], relative to the enormity of issues facing the non - agency market, are reasonably insignificant in my view," said Dean Di Bias, high-yield portfolio manager at Advantus Capital Management. "These are two very small victories in a very long race."