DoubleLine, AllianceBernstein and other top mortgage credit buyers are asking to remove natural catastrophe risk from credit-risk transfer bonds after watching the market quiver in the wake of two hurricanes, according to a letter from the investors’ trade group to the issuers.
The Association of Mortgage Investors is recommending that Fannie Mae and Freddie Mac strip cat risk from their CAS and STACR bonds or risk the ‘longevity” of capital currently supporting the market, according to the 25 October letter penned to CRT executives at Fannie Mae and Freddie Mac, and the Federal Housing Finance Agency.
The investors’ plea comes after a tumultuous month in CRT. Yield spreads on B1 subordinate bonds tied to high-LTV mortgages widened 125bps in the five weeks through 8 September after Hurricane Harvey left heavy flooding throughout East Texas, according to Wells Fargo Securities. The bonds widened even as the total exposure of CRT reference pools was generally less than 3%, reflecting the relatively thin credit enhancements and lofty prices after a long rally.
The high LTV B1 bonds have clawed back about 50bps of that widening as of a week ago, Wells data show.
To address the risk, of which the AMI says its members know little, Fannie Mae and Freddie Mac could begin issuing bonds in the catastrophic debt market, the AMI said.
“It does not seem wise to continue to ask CRT investors to take a risk that they simply do not know how to model or price,” the AMI said in the letter.
Concerns include climate change
The AMI noted several member gripes with cat risk in CRTs.
First, insurance companies typically don’t underwrite for flooding, and so mortgage investors shouldn’t be required to do it either, the AMI said. Second, the GSEs require insurance on multifamily properties in earthquake-prone areas, but not for the residential mortgages in CRT reference pools. Third, the GSEs have allowed mortgage insurers to write policies that exclude natural disasters, so why then can’t they do it for CRT, it said.
Furthermore, it appears there has been no actuarial effort to analyze cat risk in CRT securities. Without the specialized knowledge, the GSEs are effectively asking investors to absorb risks of climate change, the AMI said.
Perhaps anticipating a response that isolating cat risk would be too expensive, the AMI said that would confirm that CRT risk is mispriced. Mispricing could jeopardize the long-term viability of the market, it added.
Some analysts believe CRT debt already asks too little of investors. Senior mezzanine bonds pay down so quickly that they will likely cease to exist by the time reference loans see losses, according to an analysis by former Fannie Mae CFO Timothy Howard, as reported. Riskier mezzanine debt, under today’s underwriting standards, would also be an ineffective cushion, he said.
But Freddie Mac may empathize with the AMI after taking steps to sweeten its last two STACRs for investors. In those deals, Freddie removed loans backed by properties in FEMA disaster areas, according to ratings reports.
Fannie and Freddie spokespeople declined to comment. A spokesperson for the FHFA did not return a call.
by Al Yoon