First Union Corp. sees significant benefits in teaming with Freddie Mac to securitize home equity loans.
Executives at the banking company - and Wall Street researchers - reason that with Freddie Mac's guarantee on subprime securities, investors won't demand as high a return, because the products will be seen as less risky.
The results: "lower interest rates that we can pass on to borrowers and that will make us more competitive," said Wesley M. Jones, managing director with First Union Capital Markets, the unit that handled the loan securitization.
Freddie Mac's name and buying power are seen as a key to bringing down home equity rates that now typically hover in the mid-teens. "This could be a new dimension for subprime lending," Mr. Jones said.
If Freddie Mac succeeds, it wouldn't be the first time. The company and rival Fannie Mae, through their support, are credited with making the market for conventional mortgagers more affordable to borrowers and less volatile to mortgage security investors.
The First Union securitization involved $227 million of home equity loans that carry interest rates between 7% and 16.5%. The loans were packaged as a real estate mortgage investment conduit, or Remic, with various pieces, or tranches, carrying different interest rates and maturities.
As structured by First Union Corp. the securitization carried an A rating. The designation was bumped to triple A - the highest rating - when Freddie Mac's guarantee was applied. In return for its guarantee, Freddie Mac receives a fee of several basis points, culled from monthly loan payments.
Freddie Mac insists no public or government money will be at risk in this deal or others that will follow. "People assume that there is, because we have a government charter," said Freddie Mac spokeswoman Sharon McHale. "But our offering documents couldn't state more explicitly that there is no government guarantee."
At the same time, Freddie Mac wants to protect its interests, and has structured the deal to allow little room for failure. Excess cash flows create an extra cushion, overcollateralizing the deal.
Freddie Mac also required that the loans be evaluated by its automated underwriting system. And the company demanded "enhanced servicing features" including a requirement for First Union to be extra zealous about keeping payments current.