Not Everyone Is Swearing Off Subprime Market

While much of the mortgage industry has been backing away from the troubled subprime credit sector, Fannie Mae executives said in a recent conference call with investors and analysts that they anticipate opportunities to grow that aspect of their business.

To be sure, Fannie Mae CEO Daniel Mudd said that subprime remains a small part of Fannie Mae's overall credit risk exposure. Fannie Mae estimates that just 2.2% of its total single-family book of business consists of subprime credit quality loans. Currently, Fannie Mae reports having over $50 billion of private-label, subprime MBS.

And subprime ARMs with short-term resets - the loans considered most susceptible to payment shock - account for 1.5% of the company's total portfolio.

Much of Fannie Mae's involvement in the subprime market involves buying "highly rated tranches" of private-label mortgage securities backed by subprime loans. In addition, Fannie Mae typically adds credit enhancements to limit loss exposure.

Still, Fannie Mae acknowledged in a recent SEC filing that its participation in the subprime sector increased during 2006, and company executives said they may continue to grow the subprime segment of the business.

But at the same time, Mr. Mudd warned that any expansion of Fannie Mae's role in subprime mortgage finance will depend on market conditions.

"I think we are reasonably prepared to play a somewhat larger part in the market, but it's really going to depend on what happens in the market," he said. "The pricing has been too tight for my taste to the higher credit quality. As you continue to see the news unfold in subprime, that may change and that may create opportunities where we think the risks and the opportunities match up better."

Upcoming regulatory guidance on nontraditional loan products will also be taken into account, he said. Enrico Dallavecchia, Fannie Mae's chief risk officer, said Fannie Mae already sees signs of improvement in subprime risk management.

"We are beginning to see a renewed recognition of risk in the market and more appropriate pricing for that risk," he said.

Fannie Mae estimates that in the third quarter of last year, subprime credit accounted for $1.3 trillion of all outstanding residential mortgage loans. Short-term hybrid loans accounted for an estimated $850 billion of the subprime total.

Among subprime asset-backed securities issued in 2006, the "early payment" delinquency rate is a stunning 5.5%, he said. Fannie attributed that number to data from LoanPerformance, San Francisco.

"This is a large market that is seeing heightened pressure from all directions."

Mr. Dallavecchia acknowledged that delinquencies in subprime mortgage securities have risen and "show no signs of abating."

"Unfortunately, there doesn't appear to be any obvious catalyst for improvement on the horizon," he said.

But Mr. Dallavecchia said Fannie Mae is better positioned to withstand credit deterioration in the residential sector than most lenders, though the company expects credit losses to trend upward.

Only 7% of Fannie's total book of business consists of loans with an original loan-to-value ratio exceeding 90%, he said. The average LTV on Fannie's portfolio today is estimated at 55%.

Fannie Mae estimates that 5% of the total book of business consists of loans where borrowers have credit scores below 620.

In the subprime mortgage area, Mr. Dallavecchia said the nature and scale of Fannie Mae's participation should insulate the company from "material losses" from deteriorating credit.

"We recognize that our participation in this large and fast-growing segment will become increasingly important to our mission. And we believe we are positioned to become more active in this market as our view of risk-return dynamics becomes more favorable," he said. (c) 2007 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com http://www.sourcemedia.com

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