By changing the way it handles delinquent mortgages backing the securities it guarantees, Freddie Mac is avoiding immediate recognition of market losses that it believes understate the salvageability of such loans, thereby preserving capital.
The government-sponsored enterprise said Monday that capital concerns had prompted it to raise the bar for buying past-due loans out of securitized pools. Before, Freddie would generally repurchase loans after four months of delinquency; now its policy is to do so only under more extreme circumstances, such as a foreclosure or modification.
Freddie must advance principal and interest payments on nonperformers that remain in its pools to bondholders. The GSE said it would rather do that than take a mark-to-market hit when it puts a delinquent loan on its balance sheet. Most such loans are eventually cured or prepaid, Freddie said, while the market losses deplete capital — something it is trying hard to shore up right now.
Freddie's move follows a recent decision by Fannie Mae to stop including mark-to-market losses on repurchased delinquent loans when calculating its loss ratios. (On Monday, Fannie would not discuss its policy for purchasing delinquent loans.)
Ajay Rajadhyaksha, the head of the U.S. fixed-income strategy group at Barclays PLC's investment bank in New York, said both GSEs are taking the position "that the market prices for these delinquent loans right now do not reflect actual recovery rates. It means that they are essentially getting unfairly penalized on a mark-to-market basis, and their capital is being impacted for reasons that are not true indicators of economic losses."
Of course, it is impossible to say for sure whether market values are off.
"If home prices decline a lot, then the market might be … underpricing the extent" of losses associated with delinquencies, Mr. Rajadhyaksha said. "To some extent they are pushing out" into the future "capital charges that might accrue to them because of these losses if the mark-to-market for these loans do reflect actual losses that will be forthcoming."
Still, the change make may sense nevertheless, if the environment for raising capital improves over the next six to nine months, Mr. Rajadhyaksha said.
"Even if the credit losses do wind up being larger than they initially thought," conditions for raising capital may improve, he said. "If it happens nine months down the line, it's much easier for them to tackle it," particularly as the GSEs accrue benefits from recent increases in pricing for guarantees.
Freddie has complained that market values for delinquent loans do not reflect its expectations for losses on such assets. "We think there's a lot of panic affecting those markets at the moment," said Sharon McHale, a spokeswoman for Freddie.
However, she downplayed the role that factor had in Freddie's decision to change its buyout policy. "That's not really what's driving this," she said. "We're not getting rid of the loans, we're just accounting for them differently."
Anthony S. Piszel, who became Freddie's chief financial officer in March, determined that the old policy was "not providing as accurate a reflection of our delinquent loan performance and our financial results as … it should," Ms. McHale said.
"When you pull them out of the pool, you're saying this is a delinquent loan, and you have to account for it as a delinquency, even thought the majority of those loans will cure or prepay," she said.
Evan Gentry, the chief executive of G8 Capital LLC, a Ladera Ranch, Calif., company formed recently to invest in distressed mortgage assets (see related story), said that "the market is panicked and there's no liquidity in the market, so therefore delinquent loans are being sold at discounts."
But that does not necessarily mean the market is overestimating losses, he said; the absence of investor interest has only created room for "a little better deal than you would otherwise" find.
"The price that we're seeing on the street, that we're paying for these loans," is "pretty fair value," Mr. Gentry said. "There is no question there are going to be real losses in these loans."
Freddie posted a third-quarter loss of $2 billion, largely because of credit provisions of $1.2 billion and credit-related, mark-to-market losses of $2.3 billion.
Mr. Rajadhyaksha said that when Freddie was buying loans out of pools after only four months of delinquency, "the minute you … brought it on to your balance sheet you had to figure out what the market price was, and then it ate into your capital immediately. But now that they are capital constrained, that is not something they want to do."
Under the new policy, Freddie said, it may also buy loans out of pools if they have been delinquent for two years or if it determines the "cost of guarantee payments to security holders … exceeds the cost of holding the nonperforming loans."