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Fitch Affirms Freddie Mac; Removes Sub Debt & Preferred Stock from Rating Watch Neg.

NEW YORK -- Fitch affirms Freddie Mac's short-term, long-term, subordinated debt and preferred stock ratings. Additionally, Fitch removes the subordinated debt and preferred stock from Rating Watch Negative. The Rating Outlook for all rated instruments is now Stable. A full list of ratings is detailed at the end of this release. Concurrently, Fitch assigns a '1' support rating to Freddie Mac. Support ratings communicate Fitch's judgment on whether an entity would receive support should it run into significant financial difficulties. The '1' support rating reflects Fitch's opinion that Freddie Mac's senior debt obligations and guaranteed mortgage-backed securities would receive external support should it become necessary.

Fitch placed Freddie Mac's subordinated debt and preferred stock ratings on Rating Watch Negative in June 2003 and subsequently downgraded those ratings in August 2003 as internal control, accounting and management issues unfolded. The Rating Outlook has returned to Stable following demonstration of Freddie Mac's ability to sustain solid business performance, address pricing pressures, enhance the accounting and financial reporting infrastructure, and progress towards timely and accurate financial reporting.

Although Freddie Mac is not yet current, it has made substantial progress in improving its control environment. Fitch is disappointed that additional delays were announced and that infrastructure enhancements still remain to be completed. However, management has shown a strong commitment to addressing accounting control and systems deficiencies, and Fitch is comfortable that those remaining items will be remedied in due course.

After market share erosion in 2003, Freddie Mac has successfully improved its position relative to competition through wider acceptance of expanded loan products, participation with additional sellers and opportunistic advances. Since Freddie Mac's business model is dependent upon continued and unimpeded access to the capital markets, Fitch has been encouraged that investor confidence has remained high throughout the entire remediation process. Fitch is also encouraged that Freddie Mac has maintained capital levels well in excess of regulatory guidelines. Notwithstanding Freddie Mac's market share gains, the government-sponsored enterprises' (GSEs') share of the overall residential mortgage market has slipped given the proliferation of private label issuances, and bears monitoring.

Fitch acknowledges that Freddie Mac's business strategy has been undergoing a gradual shift towards increased purchases of floating-rate and alternative mortgage products, reflecting the greater significance of private-label issuances in the secondary market. This adjustment, in combination with rising levels of callable debt issuance, has reduced Freddie Mac's reliance on derivatives to manage its interest rate risk. Its duration gap measures have remained in a consistently narrow band. Although fixed rate product still comprises over 60% of the total retained portfolio, the percentage of floating-rate product, particularly alternative mortgages, has been increasing.

Fitch remains comfortable with Freddie Mac's risk management capabilities. Both interest rate risk and credit risk metrics reflect limited exposure to stress scenarios. Although credit losses have been low, Fitch expects a modest increase stemming from a natural cycle from historically low levels as well as the expansion into non-traditional mortgage products.

In October 2005, Freddie Mac's board approved a capital management initiative that plans for common share repurchases of up to $2.0 billion and the issuance of corresponding non-cumulative perpetual preferred stock. Fitch remains comfortable with the company's capital base as preferred stock would comprise approximately 18% of core regulatory capital. The transaction would be considered neutral from a regulatory capital perspective. Based on the current treatment of hybrid issues, Fitch would cap preferred issues at 30% of total capital.

Fitch will continue to monitor Freddie Mac's ability to sustain market share and profitability, and confront competitive challenges from the private-label market. Fitch expects the firm to expand its acceptance of alternative mortgage product and hedging instruments. The net interest margin may remain pressured with a flat yield curve.

In addition, legislation may present additional charter challenges resulting from the potential for portfolio limits or further regulatory capital changes. In Fitch's opinion, there is a good possibility that limits will be placed on the size of Freddie Mac's mortgage portfolio in 2006, either through an agreement with its regulator similar to the temporary cap of Fannie Mae or through legislative efforts by Congress. Since interest income from the retained mortgage portfolio represents a majority of the company's overall profitability, any restrictions to add loans to the portfolio in a rising rate environment will hinder the company's operating performance on both a fair value and GAAP basis longer-term. Based on the proposals that have been discussed, Fitch continues to believe the U.S. government will provide support for the senior debt obligations in the event of a financial crisis.

Ratings affirmed with a Stable Outlook

--Issuer Default Rating (IDR) 'AAA';

--Long-term senior debt 'AAA';

--Short-term 'F1+'.

Ratings affirmed and removed from Rating Watch Negative

--Subordinated debt 'AA-';

--Preferred stock 'AA-'.

Ratings Initiated

--Support '1'.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.
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Publication:Business Wire
Date:Jul 7, 2006
Words:852
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