First Union Rouses Market With Two Large Bid Lists
March 31, 2011
The Charlotte, N.C., commercial bank now owns less than $13 billion in mortgage-backeds, down from $16.5 billion at the beginning of the month. Just two weeks ago, First Union shed $2.5 billion in mortgage-backeds. On Friday, $400 million of Ginnie Mae adjustable-rate mortgage securities, or ARMs, were sold via bid list in the morning. Two hours later, First Union returned to the market to sell $800 million of collateralized mortgage obligations, or CMOs. All the bonds were sold, with dealers noting strong bidding for the bonds. First Union's CMOs were the subject of particularly feverish bidding, as yield spreads to Treasurys in the sector have tightened in recent months. Most of the non-agency CMOs -- $700 million of the $800 million were private-label issues -- were sold between 1.20 percentage points and 1.25 percentage points above the two-year Treasury note. Collateralized mortgage obligations are mortgage-backed securities that have been sliced into parts to offer different yields and different levels of risk. The $400 million of Government National Mortgage Association ARMs consisted of both new and slightly seasoned issues. They had coupons of 6 1/2% and above, with 7% most common. ARMs appeal to lenders because they pass along some of the interest-rate risk and to buyers because they offer the possibility of lower rates. The sale seems to have depressed the prices of higher-coupon ARMs. Ginnie Mae 6 1/2% ARMs were down 1/8, Ginnie Mae 7% ARMs skidded 3/32, and most other Ginnie Mae ARMs ended flat to 1/32 lower. Of $800 million in CMOs sold, $700 million were private-label issues and $100 were agency Remics. A Remic is a mortgage-backed security structured as a sale of assets rather than as a debt financing -- this allows the lender to remove it from the balance sheet, which cannot be done with debt-financing vehicles. One private-label trader speculated that First Union chose to rid itself of these bonds because it feared extension risk. Most of these bonds are considered to be one- or two-year securities, but that life expectancy holds only under relatively fast prepayment rates. Though the bonds might seem to have stable prepayment projections because they carry discount coupons, the underlying mortgages have high 9% rates. Prepayments, which occur when homeowners sell, refinance, or make larger-than-scheduled mortgage payments, erode the value of mortgage-backed securities because they return principal early and reduce interest earnings. If the bond market bears are right and rates soar, then these mortgages could stop prepaying. That could transform these two-year securities into ones that could last until year 2018, in theory. ``Huge extension risk,'' is the way one trader characterized it.
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