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Tuesday, November 1, 2016 - 15:48

Freddie Mac Has Positive Third Qtr But Taking Precautions

--CFO Sees Possible Precursors to Credit Deterioration

WASHINGTON (MNI) - Freddie Mac is taking precautions to guard against a future deterioration in mortgage credit quality signaled by any "precursor" in credit card and auto loans despite its positive earnings result for the third quarter, an improvement in the single-family mortgage delinquency rate and continuing stellar performance of multi-family mortgages, Freddie Mac executives said Tuesday.

Freddie reported $3.6 billion in net interest income, $2.3 billion in net income, a $2.3 billion payment to Treasury and a 6 basis-point improvement in the single-family mortgage delinquency rate, to 1.02%. Delinquencies in apartment building mortgages, officials said, continue to be near zero.

But most striking in the earnings call company executives held with reporters was the observation by CFO Jim Mackey that there are hints of deteriorating mortgage quality ahead, despite stiffer underwriting standards that have improved mortgage performance dramatically since the financial crisis.

While there is yet no deterioration in Freddie's own portfolio of mortgages, "We've certainly seen other asset classes in other institutions see a modest pickup in delinquencies so we took that into account when we set our reserve levels for this quarter," Mackey said.

"Again, nothing specific to our portfolio but it does appear that changes in delinquencies in other asset classes could be a precursor to some delinquency changes to mortgages," he said.

Asked by Market News International to elaborate, Mackey added other factors, such as "the economic environment -- unemployment rate, home prices, all the typical things." The unemployment rate, at 5.0% in September, will be updated for October on Friday morning. When the unemployment rate first hit 5.0% last year, it was the first time it had been that low since April 2008. In between it soared to as high as 10.0%.

"Your models look at past history and extrapolate future performance," he continued. "So if you've been in a period of good performance the models aren't necessarily going to pick up future performance and that is why you apply judgment to your reserve levels."

What Freddie has done in the latest quarter "is we've looked at other asset classes and what they're doing and typically you start to see in credit cards or autos and loan sectors like that -- tend to see changes in delinquency rates before you see it in mortgages. So nothing specific, but more judgmental about where delinquency rates may go in the future," Mackey said.

Freddie CEO Donald Layton reminded the existing line of credit with Treasury of $140 billion is far more than stress tests suggest would be necessary even under the worst scenario. While no drawdown is anticipated, if it ever becomes necessary it could galvanize Congress into a spasm of anti-bailout legislation many analysts fear could end up being a housing finance system a lot worse than conservatorship.

As time has gone by since the government sponsored enterprises were taken over by the government, their once enormous profits -- bolstered by faded one-time gains -- have been shaved to the point losses can no longer be ruled out and, in fact, Freddie Mac posted a loss in this year's first quarter.

Fannie Mae reports its third quarter results Thursday morning.

In the presidential campaign, the future of housing finance is being ignored even more as an issue than the need for Social Security and Medicare reform.

That Freddie and Fannie Mae are generating any profits only to turn them over to Treasury is a sign for some analysts that homeowners are being charged too much for the minimal risk they now pose since mortgage underwriting was tightened after the financial crisis.

On the other hand, shareholders of the GSEs, whose shares haven't been traded but still are outstanding, rue the day the Treasury Department according to terms written into the 2008 Housing and Recovery Act began collecting what they feel is rightfully theirs. Should the GSEs someday operate under some other arrangement outside of conservatorship, the shares could be worth something again, a huge boon some hedge funds and other investors can now only dream about.

While GSE investors are still waiting to be paid for the chance they took on the shares, potential homebuyers are sharing the pain as higher GSE guarantee and other fees feed back into the costs they pay for a mortgage.

Should Republicans enjoy an election trifecta, getting the White House along with the House and Senate, there would likely soon be a push to finally put conservatorship in the rear view mirror, allowing Freddie and Fannie to keep what they earn, build up capital once again, pay dividends to investors instead of Treasury and see shares worth something. It's an outcome that some Democrats favor as well.

The 10% annual dividend Treasury gets on senior preferred GSE shares is a yield deliberately set high enough to give private companies room to compete for mortgages but so far that's never happened to any great extent.

Meanwhile what are regarded among some analysts as the GSEs' excess earnings are being diverted in part to state funds that subsidize mortgages to make houses more affordable, one other complaint of many congressional Republicans.

Proposals to recapitalize the GSEs does not eliminate the original problem, the implicit government guarantee by which taxpayers stand behind the risks the institutions would resume taking in behalf of shareholders. It became explicit after the crisis, with dedicated lines of emergency credit.

Should Democrats win the White House, the House and Senate, the proposal of a possible future Democratic Treasury secretary, economist Gene Sperling, to make Fannie and Freddie one big government agency could be on the legislative agenda.

While not advancing a plan for the future of Fannie and Freddie in the nine years since the financial crisis, Democrats and Republicans last year joined in putting handcuffs on Treasury, preventing any big change in the current arrangement for two years. Several congressional leaders were afraid the Obama administration otherwise would find a way to impose some reform plan of its own through administrative action. The handcuffs measure got scant notice when it was added to the latest debt crisis Band-Aid legislation last year.

In fact, should former Congressman Mel Watt decide to leave the leadership of the federal agency overseeing the GSEs, the Federal Housing Finance Agency, many members of Congress are afraid his parting gift would be a kind of poison pill setup for the GSEs, providing a bigger incentive for private actors in the mortgage market in a way to keep affordable housing goals alive while ending conservatorship -- without the provisions Republicans consider necessary.

Meanwhile, banks are preparing to meet the latest regulations to apply to mortgage lenders and servicers, stiffer rules that go into effect January that will place them under tight deadlines to offer delinquent borrowers information on programs to avoid foreclosure.

--MNI Washington Bureau; tel: +1 202-371-2121; email:

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