Freddie Mac says the hit to guarantee fee income it took to win back some market share was worthwhile - and that it will regain the income eventually too.
This year the McLean, Va. government-sponsored enterprise lost significant share to the rival Fannie Mae. Faster prepayments on Freddie's mortgage-backed bonds led investors to favor Fannie's, making it more profitable for lenders to securitize through Fannie.
In May, Freddie announced several strategies to close the gap. One was a contract feature adjusting guarantee fees for some lenders according to how their securities performed and the types of loans they delivered.
Suppose that a lender's production has a history of prepaying slowly, but that when it sells securities guaranteed by Freddie, it gets weak pricing. Under the contract, Freddie will reduce such a lender's guarantee fees on a subsequent batch of loans.
The idea is to "make whole" any lenders that got bum pricing for Freddie-guaranteed paper, and to reward those that deliver superior collateral, said Rob Weiss, a senior director of finance at Freddie.
"We're not just blindly reducing guarantee fees to anyone coming to the party," Mr. Weiss said. "The price adjustments are not uniform, and they're not necessarily going to everyone."
For instance, if the loans a lender delivers to Freddie are "continuously and consistently prepaying more rapidly than the market, one could hypothesize that the adjustment you would get for delivering that product is not the same as someone else could get," he said. "Nor is that adjustment necessarily a price reduction."
Apparently, a lot of lenders that signed up were eligible for the fee adjustment. Freddie said Friday in its third-quarter "business information" release that "the effect of this feature has been to reduce guarantee fees on new business."
"While this strategy has contributed to increased market share that is closer to historical levels, it has put downward pressure on the average portfolio guarantee fee," Freddie said. (It did not report earnings because it is still working on a restatement of the last three years' results.)
Moshe Orenbuch, an analyst at Credit Suisse First Boston, estimated that the incentive program would reduce the average guarantee fee Freddie collects by 1 to 2 basis points over the next year.
Mr. Weiss said the company expects to stop reducing guarantee fees once the performance of its mortgage bonds improves. Lenders would no longer be eligible once they could fetch better prices for Freddie-guaranteed bonds, so the incentive "is not a permanent reduction in fees for any lender."
For now, "we think it's worth the sacrifice," Mr. Weiss added.
Freddie's share of mortgage-bond issuance relative to Fannie dropped 4 percentage points last month, to 41%, but was still well above the April low of 30%, according to Bradley Ball, an analyst at Prudential Equity Group Inc.
Freddie is also buying more from certain partners whose loans prepay slower, and buying a wider range of products, including alternative-A loans, which it once avoided.
All other things being equal, Freddie's bonds should trade at a premium to Fannie's, because Freddie pays holders earlier each month, several analysts have said.
At a press luncheon at last week's Mortgage Bankers Association convention in San Diego, Paul Peterson, Freddie's chief operating officer, was asked why Freddie paper trades at a discount instead. He answered by reiterating the ways it is trying to change that.
"The early returns on that are pretty positive," Mr. Peterson said. Recent data showed "not much difference" in the prepayment speeds for the mortgage bonds guaranteed by the two GSEs, he said.
