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February 28, 2020  

Economic Uncertainty Drags Down CRTs

The values of agency risk-transfer securities slid this week, displaying a continued correlation to the equity market.

Class-M2 bonds issued under Fannie Mae’s Connecticut Avenue Securities program and Freddie Mac’s Structured Agency Credit Risk Debt Notes with three-year lives and triple-B-plus ratings were trading on the secondary market at 263 bp over one-month Libor on Feb. 27. On Feb. 24, similar paper was trading 15 bp narrower.

That amounted to a 6% move, closely tracking a decline the S&P 500 Index experienced over the same stretch amid growing concerns that the coronavirus outbreak will dampen economic activity.

Agency risk-transfer bonds have a history of moving in tandem with the stock market, with investors considering the instruments more exposed to macroeconomic conditions than other structured products. That’s because most of the securities are unsecured obligations of Fannie and Freddie with principal balances tied directly to defaults within their referenced mortgage pools — as opposed to being backed by payments from borrowers.

For that reason, investors said they weren’t completely shocked when risk-transfer securities began to lose value this week. But at the same time, they are warning that the recent spread widening soon could leak into other asset- and mortgage-backed bonds should broader financial-market patterns suggest danger for exposures to corporate or consumer credit.

“CRT has always been the canary in the coal mine for structured products,” one buy-side professional said. “They’re always the first to take the brunt of broad market contagion.”

While risk-transfer securities often have proven volatile, the recent move toward wider spreads follows a period of stability that began at the start of this year. The deals’ most widely traded classes, with ratings of triple-B-plus down to single-B-minus, saw their spreads move out by 5-15 bp.

The shift occurred amid light trading, however, as 8,200 industry participants descended on Las Vegas for the Structured Finance Association’s “SFVegas 2020” conference on Feb. 23-26. Should the widening continue after those people are back at their desks, the thinking is that concerns of a deeper downturn would grow.

Trading of other structured products was minimal this week, with the values of asset- and mortgage-backed bonds largely unchanged.