This is the fourth of 10 articles taking an updated look at our most widely read stories of the year. The first three can be found here: FFELPSolarCMBS.

In early September, Fannie Mae executives met quietly with over 100 investors in an office building in midtown Manhattan. Participants were invited to wander several rooms, each containing multiple computer monitors running demos of software programs the mortgage giant uses to manage the lifecycle of credit risk in loans, from pre-delivery through property disposition.

Until recently, this would have been out of character, to say the least. After all, Fannie Mae is in the very profitable business of telling others not to worry about mortgage credit risk.  But Fannie Mae and sister company Freddie Mac have marching orders from their regulator to offload this credit risk so that taxpayers don’t end up footing the bill

Over the past couple of years, they have been exploring ways to do this with a range of players including capital markets investors, insurance companies and banks. And, in an effort to produce something that mimics as closely as possible the risk in private-label mortgage securitization, they have been moving to deals with exposure to actual losses, as opposed to estimated losses.

That means investors need a much better understanding of exactly how Fannie Mae manages credit risk in order to model losses for risk-sharing transactions.

“We never had to explain this before because we kept all the risk,” Laurel Davis, vice president for credit risk transfer at Fannie Mae, told reporters at a briefing ahead of the September investor meeting. “Now we want to communicate with investors,” she said.

It appears that investors are doing their homework.  Fannie Mae’s initial offering of Connecticut Avenue Securities (CAS) with exposure to actual losses, completed in October, priced wide of the previous CAS offering in July, which offered exposure to estimated losses. But spreads weren’t just wider, they were also more tiered. Investors demanded higher premiums for tranches with exposure to mortgages with higher loan-to-value ratios (81%-97%) than for lower LTVs (60%-80%), despite the fact that the tranches carry the same ratings (‘BBB-’/’BBB’) from Fitch Ratings and DBRS.

In previous CAS, investors sometimes accepted the same spread for similarly rated tranches linked to loans with higher and lower LTVs.

Fannie Mae has said that all future CAS offerings will offer exposure to atual mortgage losses.

It is following the lead of Freddie Mac, which completed its first Structured Agency Credit Risk (STACR) transaction with actual loss exposure in March. In September, Freddie Mac expanded the program to offer exposure to the credit risk of loans with LTVs as high as 95%.

Freddie Mac has also completed several STACR transactions that offer exposure to the first dollar of losses on a reference pool of mortgages.  So far, however, Fannie Mae has no such plans. “We’ve looked at this from time to time,” Davis said at the press conference. “But we’re trying to put a cap on the losses we’d experience,” as opposed to eliminating them entirely.

She added, “If you buy car insurance you don’t have a zero deductible, it’s too expensive.”

Davis noted that, between the guarantee fees that Fannie Mae collects from lenders and the risk sharing transactions it as conducted so far, the majority  of losses that it experienced in 2006 and 2007 would have been passed on to investors.

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