Fannie, Freddie to Buy More Delinquent Home Loans

 Fannie Mae and Freddie Mac said they will ramp up their purchases of some $200 billion in delinquent home loans that the two government-controlled mortgage-finance companies have guaranteed.

Those loans were packaged into mortgage-backed securities now held by pension funds, insurance companies and other investors. Fannie and Freddie are required to buy out nonperforming loans when they modify mortgages or when the loan has been delinquent for 24 months. But now they are planning to buy more loans that are 120 days or more past due.

The moves stem from an accounting change that makes it more cost-effective for Fannie and Freddie to accelerate purchases of delinquent loans. Before new accounting rules took effect on Jan. 1, the companies were more inclined to continue making principal and interest payments to bondholders on nonperforming loans because buyouts triggered steep write-downs.

Freddie said it would buy "substantially all" of its loans that are 120 days or more delinquent. The company had nearly $70 billion of such loans it had guaranteed at the end of December. Fannie said it would "significantly" increase its purchases over the next few months and had $127 billion of loans that were 120 days or more past due.

Fannie and Freddie will hold the delinquent loans in their investment portfolios, which are financed through regular debt sales. Because the interest on that debt is less expensive than the cost of continued payments to bondholders, the companies said they expect the purchases to limit losses that could ultimately be paid by the U.S. Treasury.

"It is a positive from a perspective of the companies' finances," says Bose George, an analyst at Keefe, Bruyette & Woods Inc. But he described the move as "a negative" for investors holding the mortgage securities because they will no longer receive payments on higher-yielding bonds.

While Freddie will make a one-time purchase from its bucket of delinquent loans, Fannie's volume of defaulted loans is larger and the company will stretch its purchases over several months.

Fannie and Freddie, which were established to provide liquidity to the housing market, were taken over by the government nearly 18 months ago through a legal process known as conservatorship and have required $111 billion in capital infusions from the U.S. Treasury to stay afloat. In December, the government said it would stand behind unlimited losses over the next three years, up from the previous limit of a combined $400 billion.

Fannie and Freddie's move to accelerate bad-loan purchases will flood investors with cash at a time that the government is looking to investors to pick up the pace of their acquisitions of newly issued mortgage-backed securities. For more than one year, the Federal Reserve has been propping up the housing market by being the primary purchaser of those bonds. But the Fed is set to wind down that $1.25 trillion program, which has helped keep mortgage rates at near-record lows.

"There's going to be more than $100 billion of cash sloshing around in the hands of MBS investors," said Jim Vogel, an analyst at FTN Financial. Many of those investors will look to plow that money back into the mortgage market.

Fannie and Freddie's portfolios can't exceed $810 billion at the end of the year, and they held $772.6 billion and $755 billion, respectively, at the end of December. But the agencies' buying power will be increased because they are expecting to see those balances shrink by around $100 billion this year through natural runoff, according to estimates by Credit Suisse. That should free up additional room for delinquent loan buyouts.

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