Mortgage companies that lend to people with spotty credit records are worried that a Freddie Mac program to expand their market will create a credit-quality problem that could end up hurting all lenders in the business.
Freddie Mac says the program has the potential to draw some 500 new companies to the market - and that has established players worried. Their concern: the newcomers will lack experience in evaluating and servicing so- called B and C credits.
That, they maintain, could mean a sharp run-up in bad loans, which in turn could undermine the booming market for securities backed by subprime mortgages. And that would be a setback for all lenders trying to securitize the loans.
"If investors get burned on loans originated through this system, they are going to think negatively about the B and C market," said Hugh Miller, president of Woodbury, N.Y.-based Delta Funding Corp., which specializes in nonconforming home loans.
Freddie Mac, formally the Federal Home Loan Mortgage Corp., maintains that investors will ultimately benefit from the system because it will help standardize credit-enhancement strategies.
While Freddie, formally the Federal Home Loan Mortgage Corp., normally buys and guarantees the loans it underwrites, it is not permitted by law to purchase loans of less than prime quality. Its Loan Prospector program, however, uses Freddie's technology to evaluate subprime loans as a convenience to its lender customers.
Approved loans that are of subprime quality are then bought by Independent National Mortgage Corp., or Indy Mac, a mortgage conduit that will securitize the loans.
This in turn serves to attract more lenders into the Loan Prospector system for all their loans as Freddie Mac vies with the Federal National Mortgage Association for order flow.
Mr. Miller said one flaw in the Freddie Mac program is its reliance on credit scoring. Credit-scoring models for borrowers with good credit are still relatively new, he said, adding that the hands-on nature of subprime credit underwriting makes him skeptical of the reliability of a computer- scored system.
The program, which uses data developed by Standard & Poor's to help make the credit evaluations, is also making other rating agencies nervous.
Investors are not yet completely comfortable with credit-scoring systems in general, said James Nadler, executive vice president with Fitch Investors Service, a New York-based rating agency. "We still get questions about (prime) scoring systems."
Mitigating factors that underwriters of nonconforming credit rely on when determining a borrower's likelihood of paying back a loan - such as the condition of the property a loan is made on - cannot be written into a computer program, he said.
"We're always concerned someone will do something stupid in the industry," said Daniel Rich, chief financial officer for Champion Mortgage, Union, N.J. "This is just one more thing to watch."
He is not against Freddie's involvement in the subprime credit market, he added, just worried about lack of experience on the part of participating lenders.
Indy Mac, which will buy and securitize the loans, is a unit of CWM Mortgage Holdings. CWM in turn is a real estate investment trust managed by Countrywide Credit Industries, Pasadena, Calif., the nation's largest independent mortgage company.
Servicing the loans will be provided by either the originator or Countrywide, a fact that makes some nonconforming players apprehensive.
"These loans need individual attention," said Stanley Zimmerman, president of the National Home Equity Mortgage Association. To date, CWM's experience servicing nonconforming loans has been negligible.
Nonconforming lenders agree that the marketplace is too large and too segmented for Freddie's entry to take much of a bite out of their origination volume.
Champion Mortgage's most recent business plan, drawn up late last week, doesn't even mention Freddie's foray into the market, Mr. Rich said. "It's such a fragmented industry. I'm competing against people's rich uncles as much as banks and credit unions."