How Freddie Mac's House Stands --- Fewer Risks, Aggressive Use Of Hedging Leave Firm Looking Safer Than Its Larger Sibling
FANNIE MAE'S RECENT portfolio problems raise an inevitable question: Why hasn't Freddie Mac, its smaller sibling, suffered the same fate?</br></br>For years, investors have treated the two massive mortgage companies as if they were interchangeable, and in many respects, they are. Both are government-chartered companies that buy mortgages to boost the flow of capital through the housing market. Both have the same set of special -- and controversial -- advantages, including exemptions from some taxes and a lower cost of borrowing than other companies. And both, according to their critics, represent a potential threat to the economy if they mismanage their gigantic loan portfolios.</br></br>But at a time when Fannie Mae is scrambling to recover from a flood of mortgage refinancings, Freddie Mac appears to be doing fine, in part because of its more aggressive use of derivatives and other hedging instruments. Although both companies use such instruments to protect against rare market upheavals -- like today's extraordinarily low-interest-rate environment -- Freddie Mac uses more of them, theoretically giving it more protection.</br></br>As of June 30, Freddie Mac's portfolio of derivatives had a notional balance of $704 billion, while Fannie Mae had just $594 billion in derivatives, even though it is a much larger company. Among those derivatives are so-called interest-rate swaps and "swaptions," or options on swaps, which the companies use to help balance their assets and liabilities during periods of stress. Through the use of interest-rate swaps, for example, the companies can restructure their debt whenever interest rates shift, keeping their debts in line with their assets.</br></br>Both companies rely heavily on so-called callable debt, which can be reissued whenever interest rates change. Nevertheless, Freddie Mac estimates 75% of its fixed-rate assets are funded with such debt or other "option protected" hedging instruments, while the comparable figure at Fannie Mae is closer to 60%, according to an analysis by UBS Warburg.