Agency MBS Repackagings On the Table

A government proposal that calls for Fannie Mae and Freddie Mac to add unguaranteed subordinate classes to their mortgage-bond issues could spawn yet another new product: resecuritizations of the junior securities.

The outlook reflects plans by mortgage REITs to become major investors in the subordinate agency paper. While the concept is still in its infancy, it appears those shops would fund their initial purchases with capital already raised via stock offerings and other means, with an eye toward securitizing the holdings down the road.

A number of mortgage REITs already have been eyeing a similar approach to funding investments in pools of loans and non-agency mortgage bonds, but have been stymied by a lack of supply among those products. Investments in traditional agency debt, meanwhile, don’t carry high-enough yields to support resecuritization as a profitable exit strategy.

But agency B-pieces would appear to address both limitations. The securities would be plentiful, based on initial projections that they would account for up to 10% of each Fannie and Freddie issue going forward. And because they would represent first-loss positions without a government guarantee, they would bring higher returns than existing agency debt.

According to Sifma, $540 billion of agency bonds priced during the first three quarters of this year.

However, a resecuritization strategy would have to overcome a number of obstacles. For starters, the government hasn’t said much about the structure of the agency issues. And the REITs have barely begun to envision the repackaging process. “[A resecuritization] would have to stand on its own, and they’d have to figure out the quality of the collateral pool, performance, cashflows, servicers and whether they were newer loans or seasoned,” one source said. “If people will be looking for triple-A ratings with low credit enhancement, that’s not going to happen. But conceivably they could do a deal.”

The REITs also would have to compete for the agency paper with other buyers, including hedge funds.

The idea of adding subordinate pieces to agency deals, first mentioned in September by acting Federal Housing Finance Agency director Edward DeMarco, is geared toward luring more private capital into the mortgage-finance market. Several mortgage REITs, including Two Harbors Investments of Minnetonka, Minn., already have approached the Obama Administration and the FHFA seeking details on how the offerings would work. Their conversations are likely to influence how the program takes shape.

Redwood Trust and Springleaf REIT have been the only mortgage REITs to securitize their loan purchases since the market crash. Others, including Private National Mortgage Acceptance, approached the rating agencies with planned deals earlier this year but never followed through. “They just went radio silent,” one source said. “Everyone got excited when they got their funding, and they all have a similar gameplan. But no one came forth with loans except for Redwood.”

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