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Investment Insights What are GSE Credit Risk Transfer securities? Credit Risk Transfer (CRT) securities are general obligations of the US Federal National Mortgage Association, commonly known as Fannie Mae, and the US Federal Home Loan Mortgage Corporation, commonly known as Freddie Mac. These Government Sponsored Enterprises (GSEs) are mandated to expand the secondary market for residential mortgage loans through securitization. Fannie Mae and Freddie Mac purchase and securitize loans and sell the resulting mortgage-backed securities (Agency MBS) in the secondary market. Agency MBS are guaranteed by the GSEs, meaning that these entities are responsible for the timely payment of principal and interest on the bonds and bear the risk of credit losses on the underlying loans. CRT securities were created in 2013 to effectively transfer a portion of the risk associated with credit losses within pools of conventional residential mortgage loans from the GSEs to the private sector. Unlike Agency MBS, full repayment of the original principal balance of the CRT securities is not guaranteed by the GSEs; rather, “credit risk transfer” is achieved by writing down the outstanding principal balance of the CRT securities if credit losses on the related loans exceed certain thresholds. By reducing the amount that they are obligated to repay to holders of CRT securities, Fannie Mae and Freddie Mac are able to offset credit losses on the related loans. Background The CRT market is a product of the efforts of Fannie and Freddie’s regulator, the Federal Housing Finance Agency, to accelerate the return of private capital to the residential mortgage loan market following the financial crisis. As home prices started to decline in 2007 and the US subsequently entered a recession, defaults on guaranteed loans escalated dramatically and the GSEs suffered significant losses. In September 2008, the GSEs were placed under the conservatorship of the US Treasury and received financial support in the form of lines of credit — effectively a bailout funded by US taxpayers. The credit risk transfer initiative seeks to reduce the exposure of taxpayers to such an event in the future by placing the GSEs in a last loss position rather than a first loss position with respect to most of the loans that they guarantee. Growth The CRT market has grown rapidly since its debut in July of 2013. Investor reception has been robust as it has become increasingly difficult to source exposure to credit risk linked to the residential mortgage loan market. As of August 2016, the GSEs had issued USD 34.6 billion CRT securities.1 These transactions have provided the GSEs with credit loss protection on over USD 1.1 trillion of loans to date.1 Today CRT securities have come to represent the predominant form of non-guaranteed debt issuance related to recently originated residential mortgage loans in the US. They have enabled a wide range of investors to gain credit exposure to the ongoing recovery of the residential real estate market. We expect total issuance in 2016 of approximately USD14 billion, compared with USD12.6 billion in 2015.2 Why consider CRTs? CRT securities can help diversify the risk profile of a fixed income strategy by providing credit exposure to the US residential mortgage market. We believe this sector offers a potentially compelling opportunity due to the strength of US residential real estate fundamentals and the high quality of loans that Fannie and Freddie have acquired in recent years. Additionally, floating rate LIBOR-based coupons could help to mitigate uncertainty related to the future path of interest rates and allow investors to benefit from increases in LIBOR that have resulted from regulatory reforms. This document is for Qualified Investors in Switzerland, Professional Clients in Continental Europe, Dubai, Guernsey, the Isle of Man, Jersey and the UK; for Institutional Investors only in the United States and Australia; for Professional Investors in Hong Kong; for Qualified Institutional Investors in Japan; for Persons who are not members of the public (as defined in the Securities Act) in New Zealand; in Singapore for Institutional Investors and/or Accredited Investors; in Canada, this document is restricted to Accredited Investors as defined under National Instrument 45-106. It is not intended for and should not be distributed to, or relied upon by, the public or retail investors. Please do not redistribute this document. The loans underlying CRT have performed well in recent years as home prices increased and the labor market improved. In contrast to many other asset classes, we believe that tight supply and low mortgage rates will continue to drive sustainable home price gains. Rating agencies have recently been active in upgrading CRT securities, and we expect this cycle to persist. Looking forward, we believe an expanding investor base is likely to improve liquidity in the CRT market, and relative credit risk premiums may contract as the sector continues to mature. How IFI is different3 Invesco Fixed Income (IFI) employs a balanced top-down, bottom-up approach in our portfolio construction process. Our top-down analysis examines factors in the broader economy such as GDP growth, interest rates, labor market dynamics, consumer data and corporate earnings. Our analysis then defines fundamental trends in residential real estate such as housing stock, mortgage originations, delinquency rates, loan origination conditions and housing performance across distinct geographical areas, which, in turn, shape our outlook for the residential market and the performance of housing-related debt. Robust bottom-up credit analysis also plays an important role. For any potential investment, our analysis begins at the loan level. Key collateral and borrower characteristics including delinquency status, loan type, balance, geographic location, property type, documentation type, occupancy status, current loan-to-value ratio and credit scores are reviewed to determine appropriate assumptions for prepayment and default expectations. Property level assessments and geographically detailed home price indices are utilized to update collateral value estimates. Where appropriate for the type of security, the team formulates assumptions for variables that are influenced by transaction parties, such as the servicers that collect payments from borrowers and manage property liquidations. Once base case assumptions have been established, we perform structural analysis under multiple scenarios to determine likely cash flow profiles and to quantify the amount of projected loan loss relative to the credit protection provided by the transaction structure. How CRTs work Each CRT transaction generally includes several tranches that cover a range of cash flows, credit risk and potential return profiles. Historically, tranches with the highest credit quality have been rated A and feature a relatively short expected cash flow window and a large amount of credit protection in the form of a higher level of subordination. BBB rated tranches feature longer expected cash flow windows and lower levels of subordination. Finally, below investment grade tranches represent the longest expected cash flows and have the least credit protection, but typically offer the highest potential returns. Tranche prepayments and write-downs are based on the performance of the reference mortgage loan pool. As loans are prepaid, the most senior tranche is first in line to receive the proceeds, followed by lower-rated tranches as outstanding balances are paid off. As defaults occur, losses are allocated sequentially from the tranches with the lowest rating to the highest. Thus, below investment grade tranches experience write-downs first, and if they are written down entirely, BBB rated tranches begin to take write downs, and so on. Typical CRT Transaction Structure Last Loss Senior risk retained by GSEs Reference mortgage loan pool Lower Credit Risk Highest rated CRT classes (mezzanine risk) Lowest rated/non-rated CRT classes (subordinate risk) 1 Derived using Intex data, 31 Aug. 2016. 2 Derived using Intex data, 31 Dec. 2015. 3 Invesco Fixed Income (IFI) is a unit comprising Invesco Advisers, Inc. of Atlanta, Georgia; Invesco Asset Management Limited, of London, U.K.; and Invesco Canada Ltd. of Canada. First Loss Higher Credit Risk Important information This document is for Qualified Investors in Switzerland, Professional Clients only in Dubai, Continental Europe, Guernsey, the Isle of Man, Jersey and the UK; for Institutional Investors only in the United States and Australia; for Professional Investors in Hong Kong; for Qualified Institutional Investors in Japan; for Persons who are not members of the public (as defined in the Securities Act) in New Zealand; in Singapore for Institutional Investors and/or Accredited Investors; in Canada, this document is restricted to Accredited Investors as defined under National Instrument 45-106. This overview contains general information only and does not take into account individual objectives, taxation position or financial needs. Nor does this constitute a recommendation of the suitability of any investment strategy for a particular investor. It is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any trading strategy to any person in any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it would be unlawful to market such an offer or solicitation. It does not form part of any prospectus. While great care has been taken to ensure that the information contained herein is accurate, no responsibility can be accepted for any errors, mistakes or omissions or for any action taken in reliance thereon. The opinions expressed are that of Invesco Fixed Income and may differ from the opinions of other Invesco investment professionals. Opinions are based upon current market conditions, and are subject to change with notice. Past performance is no guarantee of future results. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Asset management services are provided by Invesco in accordance with appropriate local legislation and regulations. This material may contain statements that are not purely historical in nature but are “forward-looking statements.” These include, among other things, projections, forecasts, estimates of income, yield or return or future performance targets. These forward-looking statements are based upon certain assumptions, some of which are described herein. Actual events are difficult to predict and may substantially differ from those assumed. All forward-looking statements included herein are based on information available on the date hereof and Invesco assumes no duty to update any forward-looking statement. Accordingly, there can be no assurance that estimated returns or projections can be realized, that forward-looking statements will materialize or that actual returns or results will not be materially lower than those presented. All information is sourced from Invesco, unless otherwise stated. All data is USD, unless otherwise stated. RESTRICTIONS ON DISTRIBUTION Australia. This document has been prepared only for those persons to whom Invesco has provided it. It should not be relied upon by anyone else. Information contained in this document may not have been prepared or tailored for an Australian audience and does not constitute an offer of a financial product in Australia. You may only reproduce, circulate and use this document (or any part of it) with the consent of Invesco. The information in this document has been prepared without taking into account any investor’s investment objectives, financial situation or particular needs. Before acting on the information the investor should consider its appropriateness having regard to their investment objectives, financial situation and needs. You should note that this information: may contain references to dollar amounts which are not Australian dollars; may contain financial information which is not prepared in accordance with Australian law or practices; may not address risks associated with investment in foreign currency denominated investments; does not address Australian tax issues. Issued in Australia by Invesco Australia Limited (ABN 48 001 693 232), Level 26, 333 Collins Street, Melbourne, Victoria, 3000, Australia which holds an Australian Financial Services License number 239916. Canada. This document is restricted to accredited investors as defined under National Instrument 45-106. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This is not to be construed as an offer to buy or sell any financial instruments and should not be relied upon as the sole factor in an investment making decision. As with all investments there are associated inherent risks. Please obtain and review all financial material carefully before investing. Issued in Canada by Invesco Canada Ltd., 5140 Yonge Street, Suite 800, Toronto, Ontario, M2N 6X7. Europe and Dubai. This document is for Qualified Investors in Switzerland, Professional Clients in Continental Europe, Dubai, Guernsey, the Isle of Man, Jersey and the UK and is not for consumer use. This document is not intended to provide specific investment advice including, without limitation, investment, financial, legal, accounting or tax advice, or to make any recommendations about the suitability of any product for the circumstances of any particular investor. You should take appropriate advice as to any securities, taxation or other legislation affecting you personally prior to investment. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without Invesco’s prior written consent. Further information is available using the contact details shown: Issued In Austria by Invesco Asset Management Österreich GmbH, Rotenturmstrasse 16-18, A-1010 Wien. Issued in France by Invesco Asset Management S.A., 16-18, rue de Londres, F-75009 Paris, which is authorised and regulated by the Autorité des marchés financiers in France. Issued in Germany by Invesco Asset Management Deutschland GmbH, An der Welle 5, 60322 Frankfurt am Main, Germany. Issued in the Isle of Man by Invesco Global Asset Management DAC, Central Quay, Riverside IV, Sir John Rogerson’s Quay, Dublin 2, Ireland. Regulated in Ireland by the Central Bank of Ireland. Issued in Jersey and Guernsey by Invesco International Limited, 2nd Floor, Orviss House, 17a Queen Street, St. Helier, Jersey, JE2 4WD. Invesco International Limited is regulated by the Jersey Financial Services Commission. Issued in Switzerland by Invesco Asset Management (Schweiz) AG, Talacker 34, CH-8001 Zurich. Issued in Dubai by Invesco Asset Management Limited. PO Box 506599, DIFC Precinct Building No 4, Level 3, Office 305, Dubai, UAE. Regulated by the Dubai Financial Services Authority. Issued in the United Kingdom on behalf of Invesco Secured Senior Management, Inc. by Invesco Asset Management Limited, Perpetual Park, Perpetual Park Drive, Henley-on-Thames, Oxfordshire, RG9 1HH, UK. Authorised and Regulated by the Financial Conduct Authority. Hong Kong. This document is provided to professional investors (as defined in the Securities and Futures Ordinance and the Securities and Futures (Professional Investor) Rules) only in Hong Kong. It is not intended for and should not be distributed to, or relied upon, by the members of public or the retail investors. Issued in Hong Kong by Invesco Hong Kong Limited 景順投資管理有限公司, 41/F, Champion Tower, Three Garden Road, Central, Hong Kong. Japan. This document is only intended for use with Qualified Institutional Investors in Japan. It is not intended for and should not be distributed to,or relied upon, by members of the public or retail investors. Issued in Japan by Invesco Asset Management (Japan) Limited, Roppongi Hills Mori Tower 14F, 6-10-1 Roppongi, Minato-ku, Tokyo 106-6114, Japan, which holds a Japan Kanto Local Finance Bureau Investment advisers licence number 306. New Zealand. This document is issued in New Zealand only to Persons who are not members of the public in New Zealand (as defined in the Securities Act). This document has been prepared only for those persons to whom it has been provided by Invesco. Information contained in this document may not have been repared or tailored for a New Zealand audience. This document does not constitute and should not be construed as an offer of, invitation or proposal to make an offer for, recommendation to apply for, an opinion or guidance on Interests to members of the public in New Zealand. Any requests for information from persons who are members of the public in New Zealand will not be accepted. Issued in New Zealand by Invesco Australia Limited (ABN 48 001 693 232), Level 26, 333 Collins Street, Melbourne, Victoria, 3000, Australia, which holds an Australian Financial Services License number 239916. Singapore. This document may not be circulated or distributed, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor under Section 304 of the Securities and Futures Act (the “SFA”), (ii) to a relevant person pursuant to Section 305(1), or any person pursuant to Section 305(2), and in accordance with the conditions specified in Section 305 of the SFA, or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. This document is for the sole use of the recipient on an institutional offer basis and/ or accredited investors and cannot be distributed within Singapore by way of a public offer, public advertisement or in any other means of public marketing. Issued in Singapore by Invesco Asset Management Singapore Ltd, 9 Raffles Place, #18-01 Republic Plaza, Singapore 048619. United States. Issued in the United States of America by Invesco Advisers, Inc., Two Peachtree Pointe, 1555 Peachtree Street, N.E., Suite 1800, Atlanta, GA 30309. II-GSECRT-INSI-1-E 10/16 GL331