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February 08, 2019  

Risk-Transfer Market Balks at Refinancings

Changes to the terms of risk-transfer securities issued by Fannie Mae and Freddie Mac threaten to further roil a market that saw bond values plummet in the fourth quarter.

Since the Federal Housing Finance Agency’s Home Affordable Refinance Program began unwinding at yearend, Fannie and Freddie have implemented similar programs aimed at helping borrowers with high loan-to-value ratios refinance their mortgages. What has investors worried is a provision that allows the replacement loans to remain in the collateral pools of Freddie’s Structured Agency Credit Risk offerings.

Investors are well aware that loans refinanced under HARP carry higher risk than most agency mortgages, given loan-to-value ratios that can exceed 100%. But that wasn’t a concern for holders of risk-transfer bonds because the original loans ceased to exist upon refinancing — and the replacement accounts weren’t allowed in the securities’ reference pools.

“The new treatment will affect CRT bonds in two ways: extension risk and default rates,” Bank of America researcher Chris Flanagan wrote in a Feb. 1 report.

The first risk-transfer securitization issued under the new terms was a $750 million offering that Freddie priced on Jan. 23 via underwriters Barclays and Wells Fargo. Buyers demanded higher-than-expected yields. For example, an $86 million tranche of unrated bonds with 10-year lives was marketed at 950-975 bp over one-month Libor. It priced at 1075 bp.

An investor in the deal said investors were reacting to the so-called Enhanced Refinance Program that Freddie set up to replace HARP. “Once we saw the ERR provision, we started pushing back,” he said.

Fannie’s refinancing program for troubled borrowers, called High LTV Refinance Option, likely will be in effect for the agency’s next risk-transfer securitization. The deal is expected to hit the market in a month or two. While Fannie hasn’t said exactly how it will deal with loan refinancings, it is expected to follow Freddie’s lead and allow those mortgages to remain as bond collateral.

“Having these refinanced loans in new deals is not something I’m really comfortable with right now,” another investor said.

Risk-transfer paper that had been trading at par as recently as August dropped to 93 cents on the dollar in December. Prices have since recovered somewhat, with bonds changing hands this week at about 98 cents on the dollar.

The FHFA launched HARP amid the “great recession” to help borrowers whose home values had fallen below the balances on their mortgages, making it impossible for them to refinance. HARP didn’t provide for a reduction in principal, but it did allow borrowers to obtain new loans with lower interest rates and longer repayment terms. The replacement programs run by Fannie and Freddie offer essentially the same terms.