Fannie Mae and Freddie Mac may be taking sharply divergent approaches to a common problem: Their role in the mortgage market is shrinking, because of heated competition and changing consumer preferences.
In comments this week, Freddie sounded enthusiastic about hot products like hybrid adjustable-rate mortgages, while Fannie’s tone was markedly standoffish.
Freddie’s president, Eugene M. McQuade, said Thursday in an investor presentation in London that it wants to play a bigger role in the financing of hybrid ARMs, even though it believes rising rates will cut into their popularity.
“I think customers are now either being educated or are educated … that they don’t need to buy 30-year … protection,” he said.
“My sense is that secularly, you will see a shift.” Even as rates rise, consumers will still choose mortgages where the rate is fixed for no more than the first 10 years, “knowing that’s about all the protection they need to buy,” Mr. McQuade said. “That leaves us with the strategic challenge of what do we do about that.”
The rising percentage of ARMs in the industry origination mix has contributed to (and, in part, resulted from) the explosion of private-label securities — those not guaranteed by Fannie, Freddie, or the Government National Mortgage Association — which have sucked up many of the riskier loans and those with unusual features. That rising popularity of ARMs has also let banks retain more loans. Freddie needs to be “in a position to buy each and every one of those mortgages,” Mr. McQuade said.
To do that, it must keep pace with innovations by originators like Washington Mutual Inc. by developing a “stronger product set,” he said. The “option” ARM, which allows for negative amortization and was once offered mostly by Wamu and Golden West Financial Corp., is now a big seller for a wide swath of lenders.
“We’re focused now not only on competing against Fannie Mae but also the proliferating private-label securities market,” Mr. McQuade said.
By contrast, in a securities filing Wednesday, Fannie laid much of the blame for its loss of business on the rise of risky loans that it indicated it does not want. It said its “overriding focus” has been to remain “disciplined” amid the competition. For this reason, Fannie said it foresees ongoing pressure on its growth and returns.
Analysts said Fannie’s complaints were well known, but some said the filing’s tone indicated an increased bearishness. “I’m not sure that any of it is new, but they just incrementally highlighted that the situation is worse than anyone was aware of,” said Ed Groshans, an analyst with Fox-Pitt, Kelton Inc.
Fannie said the private-label share of MBS issuance rose to about 54% in the first quarter, from 44% for all of last year. The 2004 level was more than double that of each of the previous two years. Fannie’s share of issuance fell to 24% in the first quarter, from 29% last year, 45% in 2003, and 41% in 2002.
“If current market conditions continue, the prevalence of private-label issuance and the growth of what we believe are higher-risk assets backing these securities may also continue,” Fannie said.
Fannie is making some changes to deal with the affordability issues driving the use of products like ARMs and interest-only loans. Next month it plans to broaden its use of a 40-year mortgage, which it currently offers to credit unions. Such loans cut monthly payments by spreading the amortization of principal over a longer period.
Moshe Orenbuch, an analyst at Credit Suisse First Boston Corp., said Fannie’s accounting fiasco would have to take priority. “I think they have to focus on fixing that before they can focus on an expansion of the types of loans they want to securitize.”
