Specialty lenders report feeling an ominous ripple as Freddie Mac and Fannie Mae dip their toes into the home equity and subprime mortgage pool.
The big government-sponsored enterprises say the nontraditional loans remain a negligible part of their businesses. But at last week's National Home Equity Mortgage Association conference in Orlando, a surprising 40% of those contacted by the trade group said they have already sold loans and securities to the two enterprises.
With about $280 billion of loans outstanding, the subprime and home equity market is only a fraction the size of the trillion-dollar-a-year conventional mortgage market, so Fannie and Freddie loom disproportionately large. And with this a sense of alarm has emerged that mirrors concerns about the GSEs among conventional lenders.
Thanks to an implicit government guarantee of their debt, Fannie and Freddie "have a lower cost of funds, and they don't pay state and local taxes," said Richard Gravino, president of Provident Consumer Services in Cincinnati. "Therefore they have an advantage over your normal business operations. If they get into the business, the real concern is their ability to reduce rates. And if they reduce rates, do they have the ability to compensate for the risks taken?"
Fannie and Freddie say their purpose as GSEs is to reduce the cost of homeownership. But the home equity and subprime specialists, who overwhelmingly believe that the profit motive - rather than their social mission - has led the two GSEs into the new market, are warning that their participation could have the opposite effect.
"Certainly one issue as Fannie and Freddie start to take A-minus product out of the mix is that it may make B, C, and D product more expensive," said Jeffrey Zeltzer, executive director of the trade association. referring to different gradations of creditworthiness in the subprime market.
Because lenders would no longer be able to use loans to A-minus borrowers to "subsidize" rates to lower-rated borrowers, B-, C-, and D-rated consumers "may be faced with higher costs" he said.
The trade group also is worried that Fannie and Freddie will price the risk of the loans inappropriately. In the subprime business "it's not like you just send out a coupon book and they pay you," Mr. Zeltzer said. "Part of the cost of pricing is the cost of servicing."
The GSEs say such fears are unfounded. "We have always worked with lenders to grow their business," said Freddie Mac spokesman Doug Robinson. "We also want to bring what we can to the mortgage market in terms of efficiency [and] pricing clarity."
He said about 5% of Freddie Mac's $265 billion of purchases last year were in the subprime category, with a concentration in A-minus loans. The company hopes eventually to double that percentage, he said, but has no timetable for doing so.
Mr. Robinson said Freddie Mac buys subprime loans from its lenders, which it retains or securitizes, and provides guarantees for real estate mortgage investment conduits - or Remics - consisting of large pools of loans. He said this helps lenders with a critical mass of loans get a better price forin selling them.
The Freddie Mac spokesman said it is "a misnomer" to characterize the programs as home equity initiatives because virtually all the loans the company has bought are unencumbered first liens. But he said equity is a more important factor in evaluating loans to subprime borrowers than it is with prime borrowers.
Fannie Mae has "no plans to push into subprime" lending, said Howard Nelson, vice president of single-family business.
Fannie is beginning to offer home equity loans for home improvement and first mortgage loans that enable the buyer to finance renovations. The loans enable some borrowers to finance up to 100% of the value of the home after the improvements are completed, he said. Typically, he said, the loans are limited to 95% of the completed value.
A spokeswoman said that in September Fannie began buying loans to people with slightly impaired credit, enabling them to get a rate two points below the subprime rate they previously would have had to pay. After 24 months of timely payments, the borrowers qualify for a one-point rate reduction.
Mr. Nelson said that the programs are so new that Fannie has no estimate of their loan-purchase volume.
Provident's Mr. Gravino said Fannie and Freddie at this point are "on an information search" in subprime lending, but he said an aggressive move by two companies that enjoy the implicit backing of the government could have far-reaching implications. "They're taking debt and risk away from the private sector," he said. "They're transferring the risk to the taxpayer."
