These new securities have been strong performers, but also introduce new sources of risk into bond funds.
> Created in 2013, credit risk transfer deals are issued by Fannie Mae and Freddie Mac.
> The structures are designed to move mortgage credit risk from the agencies’ balance sheets to investors.
> The goal is to reduce the likelihood that the government (and taxpayers) will need to backstop the agencies in the event of another housing crisis.
> The deal tranches offered to investors boast relatively juicy floating coupons and have been strong performers since their creation.
> However, the securities are untested, and may not be as safe as they first appear.
What Are They?
Created in 2013, CRT deals are issued by Fannie Mae and Freddie Mac and are designed to move mortgage credit risk from the agencies’ balance sheets to private investors. Gross issuance has exploded since 2013’s first deal, reaching a cumulative total $48 billion as of August 2017. (There is a nascent market for bank-issued transfer deals, but it’s still small.) The programs are required by a mandate from the Federal Housing Finance Agency, which is still the conservator for both Fannie Mae and Freddie Mac. There are a couple of twists, but FHFA’s mandate states that the agencies should target at least 90% of new single-family agency mortgages’ principal for risk transfer.
Asset managers and hedge funds have been drawn to CRT deals by their attractive yields, as well as back-testing that suggests they would have held up well during the financial crisis. They have also been gobbled up by investors hunting a replacement for legacy non-agency residential mortgages—which have been strong performers since bottoming out during the financial crisis—as the sector has been steadily shrinking.