Risk-Sharing Deals: So Far, So Good

WE’RE HEARING a lot about Freddie Mac’s recent risk-sharing transaction—and by extension Fannie Mae’s equivalent that is currently in the works—and it sounds like people are optimistic about them even though they have some questions about them.

Here’s the deal with the one that’s been done, based on what Barclays researchers tell us in a recent cross-asset securitized research report.

Freddie issued some unsecured debt with a cash flow that mimics a first loss piece on underlying reference collateral. “The structure effectively creates credit-linked notes issued as unsecured debt with the balance of the notes affected by prepays and defaults on the underlying reference collateral,” according to Barclays.

The first deal’s reference loan pool contains loans Freddie got in the third quarter of last year that have original loan-to-value ratios between 60% and 80%. These were taken out by borrowers with fully documented incomes, and backed by collateral home prices that have risen by 9% to 10% since origination.

No losses are assigned for balance forgiveness modifications and adjustments made for rep and warranty repurchases by reversing losses. After 10 years, the bonds are called and Freddie retains the default risk.

“Defaults are defined as the earlier to occur of 180-plus-day delinquency…or termination of the loan through short-sale, REO sale, foreclosure note sale or deed-in-lieu,” according to Barclays.

“This structure protects the taxpayer from certain risks by transferring them to the private market, provides the GSEs a way to achieve true risk-based pricing of the guarantee fee and is likely to be appealing to a range of political camps,” the Barclays researchers tell us. “Importantly, it achieves all of these without affecting the agency mortgage-backed securities market.”

The researchers also tell us they believe “if this issuance from the GSEs evolves into a program, then it should help in price-discovery of the credit risk on well-defined, liquid and large cohorts of loans” by providing “a series of benchmarks against which private-label deals could price new issuance.”

As previously noted on this website, there are some questions about how banks might approach the investment in terms of risk-weighting under Basel III international accounting standards.

But Barclays researchers Sandeep Bordia, Jasraj Vaidya, Dennis Lee, Robert Tayon, Harkaran Talwar and Tejvansh Thakral tell us they believe “if the GSEs sell the risk on all their ongoing issuance, we could see a program that has annual issuance of about $20 billion to $25 billion in credit tranches, though it may be a while before this happens.”

Bonnie Sinnock is managing editor of National Mortgage News and editor of Origination News. She has been covering the mortgage industry since 1995.