How Big Is The Bite On Fannie And Freddie?

The mortgage giants' exposure to risky loans could be bigger than they say

Could the subprime mortgage flu spread to Freddie Mac (FRE ) and Fannie Mae (FNM )? These giant financial companies, which keep the mortgage market liquid by buying loans from banks and selling them to investors, are also heavily invested in subprime. In fact, they're the biggest buyers of securities backed by loans to risky borrowers. Freddie says it owns $124 billion, while Fannie reports $56 billion.

Some analysts suggest the two may even be underplaying their exposure. Part of the problem is that definitions of subprime can differ. The biggest quibble is over Freddie and Fannie's investments in securities created from pools of mortgages not issued or guaranteed by the two agencies. These so-called private-label loans total some $235 billion and $114 billion, respectively, for Freddie and Fannie. The companies include roughly half of that category in their subprime totals. But Paul Miller, an equity analyst at Friedman Billings Ramsey, says they should include more: "Subprime is in the eye of the beholder."

Taking a step back, industry-wide data show subprime and other risky loans account for the bulk of private-label issues. According to data tracker Inside Mortgage Finance, 74% of the $1.15 trillion private-label, mortgage-backed securities issued last year were not considered regular or "prime."

Still, in either calculation, subprime is only a small piece of their overall business. Freddie's total portfolio tops $2.2 trillion; Fannie's, $2.6 trillion. Both also mitigate their risk by primarily owning the highest-rated securities in the subprime group and then adding credit enhancements, extra insurance against potential losses. "The nature and scale of our participation in the subprime market should insulate us from material losses," Fannie chief executive Daniel Mudd said in a February conference call. "Having [a lot of] size doesn't mean having [a lot of] risk," says Freddie financial chief Anthony Piszel. Even Miller admits they own the "safest pieces."

Even so, problems can pop up in unlikely places. Freddie and Fannie's earnings took a hit in 2003—$212 million and $511 million, respectively—when assets backed by mobile-home loans soured. Fannie owned roughly $10 billion worth of such debt; Freddie, $2 billion.

Meanwhile, Congress is pushing the two to extend more credit to low-income borrowers. But doing so means making a deeper dive into subprime.

By Dawn Kopecki, with Mara Der Hovanesian in New York

— With assistance by Mara Der Hovanesian

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