Fannie and Freddie Built Loan Portfolios in Quarter by Purchasing Securities

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WASHINGTON -- Even with plunging volumes and heated competition from banks and thrifts, Fannie Mae and Freddie Mac are continuing their steady growth.

In its third-quarter reports, Fannie Mae, the Federal National Mortgage Association, showed a 14% hike in earnings over the period a year ago and Freddie, the Federal Home Loan Mortgage Corp., posted a 25% jump.

Their strategy has been to gain earnings by feeding their loan portfolios with their own mortgage-backed securities.

Fifty percent of Fannie's portfolio growth came from securities purchases, and most of Freddie's growth did as well.

The portfolios are "engines for earnings growth," said analyst Jonathan Gray of Sanford C. Bernstein & Co.

Moving the loans from the security to the portfolio side of the business dramatically jacks up yields, Mr. Gray noted.

After taxes, Fannie earns 13 basis points on the securities, as a fee to guarantee the credit quality of the underlying loans, he said.

Once in the portfolio, Fannie earns 65 to 70 basis points on the same loans for assuming the interest-rate risk as well, he said.

Analysts said they expect both agencies will follow this strategy to ride out a volatile market next year.

Still, some are beginning to sound a note of caution on the prospects for both companies.

Thomas O'Donnell of Smith Barney has trimmed his earnings estimates for both agencies, and upped his risk evaluation on Fannie's stock.

"They're no longer coining money," said Mr. O'Donnell. "They have to grind it out like the rest of us."

Mr. O'Donnell said he expects earnings to grow by 13% at both agencies next year, instead of about 15% he had previously forecast.

Citing a decline in industry originations, the increased popularity of adjustable rate mortgages and disarray in the MBS market, Mr. O'Donnell also has upped the risk rating on Fannie's stock from low to medium.

He continues to rate Freddie Mac as a medium-risk stock. …