Freddie Mac will begin a one-time buyout of substantially all its seriously delinquent loans — 120 plus days — in February. This activity will be reflected in the March 4 prepayment reports.

The GSE will be buying out about $70 billion in loans with an average coupon on the bonds at around 6%. If these loans were not bought out as a result of FAS 166/167, BNP Paribas analysts said they would normally have been bought out at 24-month delinquency. This unless these mortgages were in foreclosure, when they could last longer.

Considering the delinquency buildup over time, analysts assumed that the average time when investors would have otherwise gotten the coupon was at 12 months. The coupon income lost would likely be $4.2 billion (using the formula $70 billion X 6%), according to analysts.

If Fannie Mae were to follow suit, it could get a lot uglier. Fannie's delinquencies are approximately 40% higher and its balance 50% higher, which means another $8.4 billion lost.

Since Fannie Mae's credit impaired deliquencies are higher, the average coupon might be higher as well.

Overall, investors have the potential to lose more than $12.5 billion. This is an immediate hit in carry terms on the carried pools in total, BNP analysts said.

Furthermore, since the market rolled to March settlements today, TBA investors would be locked in with this sudden announcement. The price impact might only be compounded, analysts said. 

Freddie Mac, it should be noted, said that it will continue to buy loans out at 120-day delinquency, which means prepays should stay elevated, although not by much. What remains, however, would by no means be a low prepay product. This makes the likelihood of price appreciation quite low.                                                  

Looking back, Fannie Mae experienced considerable investor backlash in 2007 implementing a similar policy, and then in 2002 when it implemented the deal cleanup call only to reverse it, BNP analysts said. 

Fannie Mae and Freddie Mac came up with different pricing points at first for the Home Affordable Refinance program, so these issues are not necessarily in synch, according to analysts.

Overall, there is finite possibility that Fannie Mae does not come up immediately with such a move. Or if it does, the steep losses taken in a single month might cause a considerably sufficient investor backlash to roll back this policy.

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