Freddie Mac, one of the government mortgage giants, posted a Q4 profit (which goes to the US Treasury), but that profits is lower than a year earlier.
Freddie Mac had an earnings surprise of -89 percent. Surprise!
According to the Wall Street Journal, “Freddie Mac Profit Slides on Derivative Losses.”
Mortgage-finance company Freddie Mac will send the U.S. Treasury $90 million in March, after posting a fourth-quarter profit that declined steeply from a year earlier.
The company said that its fourth-quarter net income was $227 million, down from $8.6 billion in the same quarter of 2013. The profit was driven by interest income of $3.6 billion and derivatives losses of $3.4 billion.
Still, the three-month period ended Dec. 31 was the 13th consecutive quarter in which the firm showed a profit.
The derivatives losses were also not as serious an issue as they appeared. Freddie uses derivatives to hedge its portfolio’s exposure to rising interest rates. For accounting purposes, the company marks the derivatives to the market price, even as it carries many of its hedged investments at cost.
Because of that mismatch, when rates fall, as they did late last year, the derivatives can show a loss, even though the effect should even out over time.
Freddie, along with mortgage-finance firm Fannie Mae , was put into a conservatorship by the U.S. government in September 2008 after crisis-era losses.
Freddie received about $71.3 billion in support from the Treasury. After the expected March payment, Freddie will have paid back $91.8 billion.
Freddie doesn’t make loans, but buys them from lenders, wraps them into securities and guarantees to make investors whole if the loans default.
As policymakers continue to debate the future of the companies, Freddie and Fannie are slowly reaching what could be described as a normal operating environment. Although the companies’ profits had been partly driven by large post-crisis settlements with lenders on crisis-era mistakes, much of that is behind them.
“The ’Great Recession’ is passing through. We’ll have fewer giant swings in credit losses…There are a declining amount of special items,” said Freddie CEO Donald Layton . “We expect less and less of that kind of stuff to deal with.”
Likewise, as home prices have risen and borrowers’ credit quality has improved, Freddie has seen fewer defaults. Freddie said its single-family serious delinquency rate at the end of the year was 1.88%, its lowest since January 2009.
Lenders for the past few years have been loath to make loans to borrowers with anything less than pristine credit, in part because of the steep penalties that they faced from Fannie and Freddie after the financial crisis.
Late last year, the companies reached an agreement with lenders clarifying their liability for making loan mistakes in an effort to entice lenders to make loans to creditworthy borrowers with worse credit scores and lower down payments.
Mr. Layton said that on average, lenders have been moving to offer more loans to such borrowers, though some have been quicker or slower to lessen the requirements.
Richard “Dick” Bove is still recommending purchasing Freddie Mac stock, despite the downturn in earnings.
And from Bloomberg, Freddie Mac’s total book of business decreased for the first time since August, declining 0.8% in January after rising at its fastest pace since December 2009 in the final month of 2014. Freddie’s retained portfolio diverged from December’s 19% gain, falling at a 3% rate in January as it bought fewer mortgage securities. Its guarantee business slowed 210 bps from December to a 1.2% growth rate. Single-family delinquency rates continued to be a strong point for Freddie, falling to 1.86% from 2.34% a year earlier.
Freddie Mac’s mortgage-related investment portfolio must fall to $399 billion by year-end, based on its agreement with the U.S. Treasury, though Freddie is reducing its portfolio faster than required. The decline may hurt earnings through lower net interest income and operating leverage. Freddie accelerated the sale of less liquid assets, such as mortgage loans, since 4Q12. If it continues to do so, the net interest yield may shrink because most loans have a higher yield than comparable securities.
Freddie Mac could post higher GAAP earnings if interest rates rise, raising the amount paid to the U.S. Treasury. Freddie uses derivatives to hedge against movements in interest rates. In general, changes in their fair value have been positive during periods of rising rates, and negative when rates have fallen. While such changes do not reflect economic returns because the fair value of the hedged assets and liabilities may not be adjusted, any gain in net income would boost payments to the Treasury.
So, there you have it. Freddie Mac remains profitable despite the tanking of mortgage purchase applications since 2007.
As Fredo (the spiritual father of Freddie Mac) said in The Godfather,