Some mortgage-bond investors are criticizing a change in Freddie Mac debt that increases the risk of loss from homeowners who can't afford their loans.
The government-controlled company's latest version of securities that put bondholders on the hook when borrowers miss mortgage payments can now generate losses if the loans are modified, such as by having their interest rates reduced to help the homeowners, according to a document posted on its website.
"That's definitely not a welcome change," said Vitaliy Liberman, a portfolio manager at DoubleLine Capital, which oversees about $73 billion. "Clearly nobody wants to be subject to the political pressure on Fannie and Freddie to do things that could adversely affect investors."
While the change introduces a new danger for bond investors who are shouldering an increasing amount of risk previously borne by taxpayers through the deals, Freddie Mac is finding ample demand this week as it markets $720 million of the securities in a transaction tied to loans with relatively strong characteristics.
Unlike Freddie Mac's previous deals, the new structure means investors can see their principal erased by amounts generally equivalent to losses suffered by Freddie Mac on its mortgage guarantees. Previously, investor losses were amounts based on fixed percentages for each default.
Freddie Mac and Fannie Mae guarantee separate bonds backed directly by home loans, and since being taken over by the U.S. in 2008 have been able to tap government funds to make good on the insurance if needed.
The treatment of loan modifications in the risk-sharing debt comes after unprecedented steps were taken to keep borrowers in their homes. The government introduced the Home Affordable Modification Program in 2009 to set standards and provide funds for aid, and then encouraged mortgage servicers to make loan changes as part of legal settlements.
Freddie Mac and rival Fannie Mae have sold about $16 billion of risk-sharing debt since 2013, curbing taxpayer risks. Investors in previous deals only suffered damage when loans became 180 days delinquent or were liquidated at losses before then. That meant investors were leaving holders were unaffected by loan modifications that took place before 180 days of impairment.
Patti Boerger, a spokeswoman for Freddie Mac, declined to comment on the change while the debt is being marketed.
"Definitely that is a new risk, especially when you're talking about the lower tranches of the deal," said Vishal Khanduja, a money manager at Calvert Investments, which oversees about $13.6 billion. Freddie Mac's set of rules for the loan servicers that manage its mortgages "is a living document, it's not set in stone. If housing or the economy in general does experience a slowdown, things could change" in how troubled borrowers get treated.
He said the strength of the loans — which were made more than two years ago and so have benefited from the jump in home prices since then — referenced by the deal this week helps minimize the danger for those bonds.
Freddie Mac may sell the securities that are first in line to suffer losses at a yield that floats from 9.75 percentage points to 10.25 percentage point above a benchmark rate, according to a person with knowledge of the transaction who wasn't authorized to speak publicly. That compares with a spread of 10.75 percentage points on a similar slice of its previous deal last month.
Moody's Investors Service said in a report that the loans underlying the first issue of the new bonds "were all originated in 2012, at a time when home-lending activity was still contracted, and loans were made only to high credit quality borrowers using strict underwriting standards." The credit grader said that it took the risk of modification losses into account in assigning ratings as high as A3.