Freddie Mac is bringing about $140 million of rated derivative securities to market in an attempt to offset the risk of default the enterprise retains when it securitizes mortgages.

The securities, called Moderns, are not directly backed by a pool of loans as private-label mortgage-backed securities are. Their value depends on the performance of a sample, or reference portfolio, of Freddie Mac loans.

Freddie Mac declined to discuss the securities or its involvement in bringing them to market. But a Moody's Investors Service report said the complex derivatives would have the effect of a reinsurance policy.

Wall Street experts said the derivatives could provide an inexpensive way for Freddie Mac and its larger counterpart in the secondary mortgage market, Fannie Mae, to handle their residual risk.

The experts said insurance companies have executed similar transactions, involving securities called catastrophe bonds, to get reinsurance against certain risks.

The concept is not new, but this is the first time it has been applied in the rated mortgage-securities market, said Andrew Lipton, vice president and senior credit officer at Moody's Investors Service.

"This basically liquifies the residual portfolio that agencies have," said a Wall Street analyst, speaking of the potential for the derivatives. "In essence, they are buying reinsurance against defaults in the home mortgages that they have underwritten."

In the normal course of business, Freddie Mac buys loans and guarantees them-suffering a loss if the loans do not perform as expected.

The Moderns act as interest-bearing bonds, with Freddie agreeing to pay reinsurance premiums that help pay interest to investors.

Investors will lose money on the bonds if there are problems with the loans in the reference pool.

The pool includes about 147,500 loans, representing about 17.4% of the 30-year, fixed-rate, one-to-four-family mortgage loans that Freddie Mac purchased in 1996.

The mortgage loans in the reference pool are geographically diverse, were originated over the span of one year, and exclude any loan that is 30 or more days delinquent when the pool was formed, according to Moody's. The loans will be serviced by Freddie Mac-approved mortgage-loan servicers, Moody's said.

Moody's said it expects to assign a rating of Baa2 to the senior class of debt in the transaction.

The issuer, G3 Mortgage Reinsurance Ltd., is a special-purpose reinsurance company in Jersey, Channel Islands that is not owned by Freddie Mac. It was formed there for tax reasons.

Morgan Stanley, Dean Witter & Co. is the placement agent for the securities, which are not publicly registered with the Securities and Exchange Commission.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.