Investors continue to accept lower yields for exposure to the first losses incurred on residential mortgages insured by Freddie Mac.
Freddie priced $425.6 million of risk-sharing bonds Tuesday, its fourth deal of the year. The Structured Agency Credit Risk 2015-HQ2 notes offload a portion of the credit risk on $30.3 billion of mortgages that Freddie insures.
Buyers of the unrated B tranche, which transfers the first 100 basis points of losses when homeowners default, will be paid a spread of 795 basis points over one-month Libor. That’s 125 basis points less than the Libor plus 920 basis points Freddie pays investors to assume the first loss risk in its previous deal, completed in April.
The two deals are linked to the performance of similar pools of mortgages: those with fixed-rate, 30-year terms made to borrowers who financed between 80% and 95% of the purchase price of their homes.
An important difference between the two deals is that the latest one measures credit performance using a fixed definition of severity, rather than actual losses incurred on the loans. If a loan in the reference pool becomes more than 180 days delinquent, Freddie assumes it is going to default and that it will recover a fixed percentage of the principal; it then deducts amount it expects to lose from STACR holders' principal.
By comparison, the previous deal offered exposure to actual losses incurred on the reference pool of loans. It was the first time Freddie offered this kind of exposure, and the company had indicated that it planned to offer it in future deals.
"This transaction went smoothly and investor demand was strong," Mike Reynolds, Freddie Mac's vice president of credit risk transfer, said in a press release. He described the tighter spreads on B class as "a positive sign."
Not all of the tranches of Freddie’s latest risk-sharing deal priced inside previous one. The M-3 class, which absorbs the next layer of losses after the B class, pays Libor plus 325, compared with Libor plus 330 for the previous deal. But the next-riskiest M-2 class pays Libor plus 195 basis points, 10 basis points wider than the same tranche of the April deal. And the senior, M-1 tranche of the latest deal pays Libor plus 110 basis points, 20 basis points wide of the April deal.
Freddie has retained a portion of each tranche and will hold the senior loss risk in the capital structure.
Barclays and Nomura serve as co-lead managers and joint bookrunners. BNP Paribas and Morgan Stanley are co-managers, and Multi-Bank Securities Inc. is a selling group member.
In its presale report, Fitch described the fixed loss severity as a positive feature, saying it "reduces uncertainty that may be driven by future changes in Freddie Mac’s loss mitigation or loan modification policies and offers investors greater protection against natural disaster events where properties are severely damaged with limited or no recourse to insurance."
If the actual loan loss severity is above the set schedule, Freddie Mac absorbs the higher losses, Fitch noted.