Home equity experts are watching warily as Fannie Mae and Freddie Mac move forward with plans to increase their involvement in the subprime market.
Their participation "ought to bring some direct benefit to borrowers," said Brian Smith, director of policy and economic research at America's Community Bankers.
But Laura Borrelli, president of the National Home Equity Mortgage Association, expressed concern that the presence of the government- sponsored enterprises could split the market.
"The last thing that the home equity industry needs is (for Fannie and Freddie) to simply take the cream off the top," leaving other borrowers to rely on a costlier secondary market, Ms. Borrelli said.
At Fannie's investor conference in Washington last week, Franklin D. Raines, its chairman and chief financial officer, noted that the subprime and home equity markets have been growing by about 15% a year.
And, he said, with half of the $300 billion of subprime loans now "just shy of qualifying" for the prime market, Fannie Mae's automated underwriting tool, Desktop Underwriter, can help to identify borrowers who are a good risk and "offer them terms on which we can bring them into our market."
Freddie Mac's estimates are more bullish.
"Up to 20% to 30% of subprime borrowers are misclassified and should be in the A section of the market," a spokeswoman said. She said Freddie Mac has been encouraging lenders to use its automated underwriter, Loan Prospector, "even when they thought the borrower was not qualified."
Lenders have been able to use Freddie Mac's automated underwriting system to underwrite A-minus loans since October 1998, the spokeswoman said. A-minus loans represent about half of the subprime market, she added.
A spokeswoman for Fannie Mae said lenders have been able to underwrite three types of "alternative-A" loans using Fannie's automated underwriting system since November 1997.
Ms. Borrelli, of the home equity association, remains skeptical. She said she would "hate to see a large segment of the A-minus and B customers" kept out of an automated underwriting system.
Investors also took note of Fannie's and Freddie's interest in the sector. Analyst Kenneth A. Posner of Morgan Stanley Dean Witter & Co. wrote in a research note that the A-minus part of the subprime market, the alternative-A segment, and high-loan-to-value loans are areas that "could roughly double the size of the market that Fannie Mae can go after."
Mr. Posner observed that "niche product lenders," including thrifts and subprime lenders "will need to rethink their business models" as Fannie and Freddie "arm their lender and broker partners to go after these niche segments."