Trading drives majority of re-REMIC issuance

Re-REMIC issuance in the US is continuing apace, with several billion dollars worth of bonds being sold each month. While the IMF's latest Global Financial Stability Report suggests that the deals are being used to rid banks of legacy assets, rating and regulatory arbitrage, it appears that the majority of these deals are now purely done for trading arbitrage.

"There is still plenty of re-REMIC activity going on," confirms Sam Warren, md at NewOak Capital in New York. "The top broker-dealers are issuing around US$2bn each a month in re-REMICs - purely for trading arbitrage. Around 90% of re-REMIC issuance is being driven by trading arbitrage - and the other 10% is solutions-based."

Warren notes that NewOak Capital has been working on a number of solutions-based re-REMICs for insurance companies and banks across a broad range of assets. These include RMBS, CMBS and also consumer ABS deals.

"We're well off the lows in these deals in terms of valuations and many firms are looking to improve their balance sheets before year-end," he says.

According to the IMF's October Global Financial Stability Report, about US$25bn worth of re-REMICs were issued during H109, mostly against MBS backed by prime mortgages. The report notes that although these transactions have a useful role in dealing with the overhang of legacy assets, they are partly driven by rating and regulatory arbitrage.

"Maintaining triple-A status can result in substantial capital requirement reductions," the IMF report notes. "For example, the new Basel 2 risk weight on a double-B rated tranche is 350% under the standardised approach, whereas it is 40% on a triple-A-rated resecuritisation."

For single security-backed re-REMICs, the default probability-based rating methodologies used by DBRS, Fitch and S&P will typically pass the underlying bond's rating through to the new mezzanine tranche. "In this regard, it is notable that Moody's has been virtually shut out of the re-REMIC rating business, possibly because it rates on the basis of expected loss, which is tougher on mezzanine tranches than the default probability basis [Fender and Kiff, 2005], and thus issuers prefer not to have Moody's rate their potential securitisation," adds the IMF.

"Another way of looking at the differential rating treatment is that under the expected loss rating basis, a weighted average of the ratings on the two new tranches cannot exceed the old rating, so it cannot create new triple-A-rated and double-B rated tranches from a double-B minus rated legacy tranche," the report continues. "However, because the probability of default on the new mezzanine tranche is the same as that on the double-B rated legacy tranche, it also gets a double-B rating."

Re-REMICs also serve to illustrate the vulnerability of ratings-based regulations to gaming and shopping, the IMF says, adding that the new securities remain exposed to further downgrades if economic and housing market conditions worsen.

Indeed, two recently-launched RMBS re-REMICs have already been subject to downgrade. S&P has lowered its rating on the JPMRT 2009-3 Class 2-A-2 notes from triple-B minus to single-B.

The rating agency cited rapid decline in the performance of the mortgages backing the underlying certificate. The deal launched in May.

S&P also downgraded five classes of CSMC 2009-8R from double-B to single-B plus - again due to rapid deterioration in the performance of the mortgages backing the deal. That transaction launched in June.

"When a mezz bond such as that is 5 times levered to convexity and credit, a couple of bad months' performance in the underlying collateral can have a big impact. I'm not surprised that it led to a downgrade," Warren concludes.

AC