As expected, Fannie Mae continued to shrink its mortgage portfolio in May by a whopping $24 billion, and is expected to do so further in June. This is the seventh consecutive month of Fannie portfolio contraction, bringing it down to the smallest it has been since June 2003. The huge drop was from a roughly $17 billion runoff as well as $18 billion of net sales, partly offset by $11 billion of purchases.

The dip could adversely impact the MBS agency market, said analysts. "In all, the decline in the Fannie portfolio and the lack of growth in the agency side of the Freddie portfolio could continue to weigh somewhat on the agency market, particularly since there is some indication that banks have sold MBS as well," said a Merrill Lynch report, noting that although Freddie Mac's portfolio grew for the fourth consecutive month in May, all of the growth was in non-agencies. The drop's negative impact on MBS would be especially true if rates were to rally; but in a back up, analysts said mortgages should perform reasonably well.

The considerable size of Fannie's most recent shrinkage exceeds the necessary monthly reduction the GSE needs in order to meet the September deadline to build the 30% capital surcharge set by the Office of Federal Housing Enterprise Oversight.

UBS noted that the shrinkage was much more than the $13 billion per month reduction made from January to April. Furthermore, as an indication of further shedding in June, the GSE's retained commitments for the month were negative. Even with higher FAS 133 & FAS 149 charges due to the lower rate environment, Fannie "can comfortably meet the September 30 capital surcharge with only modest portfolio reductions," according to UBS analysts.

Fannie Mae disclosed that roughly $7.3 billion of the sales were from the resecrutization and sale of non-agencies. Over the year, the GSE's portfolio has dipped by $76 billion, which is equivalent to a 19.1% annualized decline.

By contrast, Freddie Mac, who released its May data a few days before Fannie, reported that its portfolio grew to $668 billion from $653 billion, which is a 5.6% annualized growth rate.

(c) 2005 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.

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