Freddie Mac has dramatically increased its presence in the burgeoning subprime mortgage market, assisting in a $407.4 million securitization last week by First Union Capital Markets Corp.
The offering, backed by more than 7,500 first and second mortgages originated or acquired by divisions of First Union Corp., Charlotte, N.C., is its largest subprime securitization with Freddie Mac.
Observers said the deal signals the advent of a wider market for riskier loans. Over the past year and half, Freddie Mac and its rival Fannie Mae have begun testing ways to help lenders make home loans available to people who might not have qualified in the past.
Lending to immigrants and to others with limited or blemished credit histories is expected to rise as a result.
"It's the beginning of a trend," said Susan M. Wachter, professor of real estate and finance at the Wharton School at the University of Pennsylvania.
Freddie Mac and Fannie Mae, which have government mandates to help expand homeownership, are using improved credit-scoring technology to identify more qualified borrowers, she said.
While Freddie Mac has focused its efforts on the so-called subprime sector, Fannie has been considering ways to finance "alternative-A" borrowers and manufactured housing among other things, said Jonathan Adams, senior analyst of financial services for Prudential Securities.
"Freddie has developed risk-based pricing as an important part of its mortgage technology," said Mr. Adams. "Risk-based pricing doesn't necessarily lead you into the subprime market, but it is a tool that allows you to price marginal risks much more accurately. It allows you to assemble a pool with much more accurate pricing."
Freddie Mac's involvement sweetens the deal for First Union and for investors because Freddie's implied government connection provides a sense of security.
"For investors, that's an important issue, particularly right now with the nervousness investors have with regard to some of the riskier products," said David Dale-Johnson, associate professor of finance and business economics and director of the program in real estate at the Marshall School of Business at the University of Southern California.
To package its loans for investors, First Union created a security which it swapped for a Freddie Mac security. First Union Capital Markets then sold the Freddie Mac certificates to investors.
Issuers of securities look for some kind of guarantee to get a better price. To obtain a credit guarantee, First Union paid Freddie a fee and Freddie in turn guaranteed the securities.
First Union Capital Markets began working with Freddie Mac about a year and a half ago, said Wesley M. Jones, managing director for First Union Conduit Programs.
"Liquidity as well as better execution has been a very big driving force behind our decisions to use the Freddie Mac structures," said Mr. Jones.
The ability to offer loans to borrowers with various credit scores and then play a role in their securitization and distribution creates a "one- stop shop" for First Union, Mr. Jones said.
Subprime home equity lending also provided an opportunity for strategic growth for First Union. "We felt that approaching a market that was underserved, particularly in our own branch system, we could boost income not only for the Capital Markets group but for the bank as a whole."
First Union Capital Markets and Lehman Brothers completed Freddie Mac home equity securitizations for $260 million in August and for $234 million in May.
Thursday's offer of Real Estate Mortgage Investment Conduits, or Remics, included primarily A-minus and B loans, with some C and D mixed in. Lehman Brothers was the dealer and co-manager for the operation.
"It's been a tough market to distribute home equity paper through the Street," Mr. Jones added.
"We felt very good about this transaction. It was well over-subscribed, and the execution was very good. It traded approximately 6 to 7 basis points tighter than private-label securitizations have been trading."
Freddie's role in guaranteeing the certificates is another way "to bring its secondary market expertise to another sector of the primary market," said Douglas Robinson, a spokesman for Freddie Mac.
"We bring in agency credit, so that enables First Union to get better financing, essentially better execution," said Mr. Robinson.
The process, he said, allows Freddie to price loans more competitively to borrowers through its customers-banks such as First Union. And the higher price in the secondary market based on the Freddie Mac guarantee enables First Union to get more money to recycle into its banking community.