Fannie Mae priced its fourth, and largest, credit risk sharing transaction under its Connecticut Avenue Securities at significantly wider spreads that its previous deal, completed in May, suggesting that the market has have  found an equilibrium.

In the two previous transactions, spreads tightened, but some of the earlier scarcity premium may have been eliminated, according to Laurel Davis, Fannie's vice president for credit risk transfer. "I don’t know we expected to hit that equilibrium so quickly, but the fact that there are lot of securities out there, that we have issuance on a regular basis, and the securities trade very transparently on TRACE … has led to them becoming a benchmark," she said.

Connecticut Avenue Securities transfer the risk of default on mortgages that Fannie insures to private investors. The amount of periodic principal and ultimate principal that investors in the latest transaction receive is determined by the performance of a reference pool of 330,000 single-family mortgages with an outstanding unpaid principal balance of $210.3 billion.  The loans were acquired in the second quarter of 2013 and are fixed-rate, generally have a 30-year term, and are fully amortizing.

The pool is dividend into two groups; group one includes loans with original loan-to-value (LTV) ratios between 60.01% and 80% and goup two includes loans with original LTV ratios between 80.01% and 97% percent. Two 10-year tranches of notes are linked to the performance of the first group and another two 10-year tranches are linked to the performance of the second group.

Pricing for the $555 million 1M-1 tranche, which is linked to group one loans and has a preliminary BBB- rating from Fitch Ratings and a preliminary BBB (high) rating from DBRS, was one-month LIBOR plus a spread of 120 basis points.  By comparison, pricing on the comparable tranche of Fannie’s previous risk-sharing deal was Libor plus 95 basis points.

Pricing for the unrated 1M-2 tranche, was one month LIBOR plus a spread of 300 basis points, compared with LIBOR plus 260 basis points on the same tranche of the prior deal. 

Pricing for the $239.5 million subordinated 2M-1 tranche, rated 'BBB' by Fitch and 'BBB' (low) by DBRS,  was also one-month LIBOR plus a spread of 120 basis points, compared with 95 basis points for the comparable tranche of Fannie’s previous deal.

Pricing for the unrated 2M-2 tranche was one month LIBOR plus a spread of 290 basis points, compared with LIBOR plus 260 basis points for the same tranche of the prior deal. 

Fannie Mae said that the  latest deal was placed with a broad distribution of diverse investors, including asset managers, hedge funds, insurance companies, depository institutions, and REITs. 

Why are investors willing to accept the same return for notes linked to mortgages with higher LTVs? Davis said that, while borrowers with less equity in their home might be a bigger risk, those making a downpayment of less than 20% are required to purchase private mortgage insurance. This limit's Fannie's losses if borrowers do default. Also, the government sponsored enterprise structured the 1M-1 and 2M-1 tranches to provide similar levels of credit protection, in the form of the subordination of the 1M-2 and 2M-2 tranches.

Fannie Mae retained the first loss and senior piece of the structure, as well as a vertical slice of the M1 and M2 tranches in both groups in order to align its interests with investors throughout the life of the deal. 

Morgan Stanley was the lead structuring manager and joint bookrunner on this transaction.  Nomura was the co-lead manager and joint bookrunner.  Bank of America Merrill Lynch, Credit Suisse, JP Morgan and Wells Fargo Bank were co-managers, and Great Pacific Securities participated as a selling group member.

Fannie plans to come to market with its next offering of Connecticut Avenue Securities in November.

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