Daniel Mudd: On the answer for Fannie Mae, on behalf of subprime, is that it's important to remember there is subprime and there is predatory. Subprime simply means--Spencer Bachus. Oh, absolutely.
Daniel Mudd.--you have a credit blemish, and we think those people are part of the market. It's less than 2.5 percent of our book. It's 80 percent insured. It's highly unsubordinated. We've been in it very carefully, consistent with some very strong anti-predatory lending guidelines we have.
Apparently, Mudd calculated the "less than 2.5 percent" by including 0.3% of the loan book that it characterized as subprime, plus 2.2% that were subprime securities.
Subprime Market: The subprime market generally refers mortgages by lenders that specialize in the subprime sector. But subprime mortgage securitizations may include loans that might ordinarily be characterized as prime. These otherwise prime loans are added to improve the overall risk profile of the portfolio, in order to attain a better credit rating. This is another reason why the numbers can be somewhat fuzzy.
The Disconnect Between The SEC Definition and the Fannie Mae Definition of "Subprime"
Here's how Fannie described a subprime mortgage in its 2006 10-K:
"Subprime mortgage" generally refers to a mortgage loan made to a borrower with a weaker credit profile than that of a prime borrower. As a result of the weaker credit profile, subprime borrowers have a higher likelihood of default than prime borrowers. Subprime mortgage loans are often originated by lenders specializing in this type of business, using processes unique to subprime loans. In reporting our subprime exposure, we have classified mortgage loans as subprime if the mortgage loans are originated by one of these specialty lenders or, for the original or resecuritized private-label, mortgage-related securities that we hold in our portfolio, if the securities were labeled as subprime when sold...
The clauses above--"using processes unique to subprime loans," and "if the mortgage loans are originated by one of these specialty lenders"-- clearly exclude Fannie's Enhanced Authorization Program from its definition of "subprime." First, "processes unique to subprime lenders," refers to processes other than those used by Fannie for underwriting Enhanced Authorization Loans. In addition, EA loans are not ordinarily offered by subprime lenders; they are all processed through Fannie's standard underwriting system, Desktop Underwriter, which is used primarily for prime borrowers. Specialty subprime lenders do not rely on Desktop Underwriter, they target consumers for higher priced loans.
And in CEO Daniel Mudd's 2006 letter to shareholders:
Affordability products: To provide an alternative to risky subprime products, we have purchased or guaranteed more than $53 billion this year in Fannie Mae loan products with low down payments, flexible amortization schedules, and other features.
Consequently, the SEC doesn't have much, if any case, in arguing that certain Fannie executives had the specific intent to deceive investors by excluding Expanded Authorization loans, and My Community Mortgage loans in its calculation of subprime exposure.
Yet that's what the SEC alleges:
115. Fannie Mae's Single Family mortgage credit book of business consisted of approximately $43.3 billion worth of EA loans and $13.8 billion worth of MCM loans as of December 31, 2006, more than 12 times greater than the 0.2% ($4.8 billion) disclosed as "subprime mortgage loans or structured Fannie Mae MBS back by subprime loans" as of December 31, 2006.
116. Nothing in Fannie Mae's public disclosures alerted investors that this much larger volume of loans matched the Company's description of subprime loans but were not included in the reported quantitative number.
It's hard to see how the SEC could get very far with that charge.
Next time: How the SEC used shifting definitions of "reduced documentation" or "reduced and alternative documentation" to measure Alt-A exposure.
(Note: You can view every article as one long page if you sign up as an Advocate Member, or higher).
1
