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By Joy Wiltermuth
NEW YORK, Aug 8 (IFR) - Several hedge funds have received margin calls in recent days on their holdings of risk-sharing RMBS bonds from Freddie Mac and Fannie Mae, market sources told IFR.
The sources said the margin calls were met, but the event still unnerved the structured finance market, which has again become reliant on cheap leverage to sustain momentum.
One banker said brokers’ margin calls required the hedge funds to pony up an extra four to five points of their equity against what they initially borrowed to purchase the bonds - understood to be more than 80% of the purchase price in some cases - to cover any losses.
“Dealers that lead these trades offer attractive financing of two to three times leverage,” one mortgage strategist said. “But if the investor is forced to unwind, it can get ugly.”
In the first quarter, some hedge funds were locking in 30-day repurchase agreements to buy risk-sharing bonds at a rate of 1.9% to lever 2.14 times, according to SEC filings.
Risk-sharing RMBS are barely a year old, having sprung up as a new asset class after US regulators issued guidelines urging the government to reduce its footprint in the massive US residential mortgage market.
Hedge funds piled aggressively into the riskier (and often unrated) tranches of the deals, looking for yield pick-up at a time when returns had shrunk dramatically just about everywhere else.
But those deals have recently tumbled dramatically. Between July 11 and July 29, the unrated bonds favoured by hedge funds gapped out as much as 50bp to roughly Libor plus 330bp in the secondary market, according to Wells Fargo data.
“Generally the sell-off has all the signs of a levered unwind,” the mortgage strategist said.
And at a time when volatility is high - Lipper this week reported the largest one-week outflow from high-yield funds ever, at more than US$7bn - the risk-sharing bonds are continuing to struggle.
On Wednesday Freddie Mac had to price the unrated tranches of its latest Structured Agency Credit Risk (STACR) trade at Libor plus 400bp and 410bp - a whopping 100bp-120bp wide of Fannie Mae’s last risk-sharing deal in July.
And while cheap money certainly enticed some players to buy into the risk-sharing sector in the first place, record volumes lately have led players to look for a way to trade out.
Approximately US$135m in risk-sharing bonds was out for bid in each of the past two weeks, the highest levels by far since the programme started in July 2013, according to Adam Murphy, president of market data company Empirasign.
Despite these stumbles, Freddie Mac is counting on being able to attract a broader base of buy-and-hold investors to the asset class - and remains optimistic.
For one thing, each of Freddie’s four STACR deals prior to July had printed at successively tighter levels, as did the three prior Fannie trades.
“Maybe spreads tightened too much and are now back to a more sustainable level,” Mike Reynolds, a director of portfolio management at Freddie Mac, told IFR.
“We definitely think the investor book should include hedge funds, and it’s natural for them to use to get the yields they need,” he said. “But we prefer to be a smaller percent of the total distribution.”
And that seems to be happening already. For the 2014-DN3 portion of the new STACR trade, 20% went to hedge funds, down from a 30% participation in April for its DN2 deal, Reynolds said.
Meanwhile the 2014-HQ1 deal - the first from Freddie to include mortgages with loan-to-values above 80% - saw just 5% participation from hedge funds. (Reporting by Joy Wiltermuth, additional reporting by Andrew Park.; Editing by Marc Carnegie and Shankar Ramakrishnan)