Freddie Mac (OTCQB:FMCC) Q2 2016 Earnings Conference Call August 2, 2016 9:00 AM ET
Sharon McHale - Corporate Communications and Marketing VP
Don Layton - CEO
Jim Mackey - CFO
Joe Light - Bloomberg
Good morning, ladies and gentlemen. Welcome to the Freddie Mac Second Quarter 2016 Financial Results Media Call. Today’s conference is being recorded.
I'll now turn the conference over to Sharon McHale, VP, Corporate Communications. Please go ahead.
Thank you. Good morning, everyone, and thank you for joining us for discussion of Freddie Mac’s second quarter 2016 financial results. We are joined today by our Chief Executive Officer, Don Layton; Chief Financial Officer, Jim Mackey; and our General Counsel, Bill McDavid.
Before we begin, we’d like to point out that during this call, Freddie Mac’s executives may make forward-looking statements, which are based upon a set of assumptions about the company’s key business drivers and other factors. Changes in these factors could cause the company’s actual results to vary materially from its expectations. A description of these factors can be found in the company’s 10-Q report filed today and its annual report 10-K.
Freddie Mac’s executives may also discuss non-GAAP financial measure. The more information about these measures including reconciliations to the most directly comparable GAAP financial measures, please see our earnings press release and related materials which are posted on the Investor Relations section of our website freddiemac.com.
Our commentary today will be limited to business and market topics. As you know, we are not able to comment on the development of public policy or legislation concerning Freddie Mac.
As a reminder, this is a call for the media and only they will have the ability to ask questions, this call is being recorded and a replay will be made available on Freddie Mac’s website later today.
With that, I'll now turn the call over to Don Layton, Chief Executive Officer of Freddie Mac.
Good morning. And thank you for joining us. I know it's a summer morning in August so I'll keep things brief today so I can get quickly to your questions. Today, I'd like to cover two things similar to the last few quarters. First, I’ll discuss the quarter's financial results. Second, I’ll highlight our progress towards our twin goals of building a better company and a better mortgage finance system for the nation's borrowers and renters.
First up, our results. It was a solid quarter in terms of both financial results and business results. We reported comprehensive income of $1.1 billion and net income of $1.0 billion for the second quarter of 2016. I remind you again that your primary focus well -- our conservative shift is on comprehensive income. We did experience the market related earnings volatility again this quarter. There was negative impact and income was very much less than the previous quarter. Specifically, interest rates in fact held steady during most of the quarter, but dropped significantly during the last two weeks as concerns over Brexit rattle the global market. In the last five business days of June following the vote, 10 year LIBOR rates declined almost 25 basis points.
This decline in interest rates during the quarter resulted in approximately a $400 million reduction in our GAAP comprehensive income. I do want to remind you once again that this impact of interest rate volatility on our GAAP results is not represent an economic loss, rather it is due to the accounting trading and mismatch between our derivatives which GAAP requires to measure it at fair value and the assets they are hedging which are not.
In addition, our results this quarter were only negligibly impacted by spreads. You may recall that we had $600 million fair loss last quarter related to widening spreads.
So without as much market related noise this quarter, the strong and improving fundamentals of our businesses are more evident, as seen in the $1.3 billion improvement in comprehensive income quarter-over-quarter. A further insight into our strong fundamentals is the adjusted i.e. non-GAAP financial measures we are providing. And which we utilize to better understand how we generate revenues and to evaluate our performance. Under GAAP the $3.4 billion of net interest income shown in the financial statements includes both traditional net interest income which is the spread earned from the investments on our balance sheet. And the guarantee fees generated by the single-family business. Multifamily guarantee fees are separately reported as other noninterest income on the income statement under GAAP.
Self explain how we generate revenues. Our adjusted figure separates these different activities i.e. generating net interest income of investments versus generating a guarantee fees from our core customer businesses. Thus we are reporting adjusted net interest income to clearly show the revenue from the investing activity including the impact on net interest income from our use of derivatives. And we are showing adjusted guarantee fees to reflect such fees from both the Single-Family and Multifamily Guarantee businesses.
I know this is solely a reclassifying of our revenues. The totals are still unchanged. Our press release shows you how this all is done. We reported adjusted guarantee fee income of $1.6 billion for the second quarter. This is up [17%] from the first quarter primarily due to increased recognition deferred fees which naturally occurs when rates decline and prepayment accelerate. In addition, I note guarantee fees continue their gradual rise as new loan volume comes on to our books at a higher level of G-fees than the average in our historic book.
Please note that the increase in guarantee fee income is especially important given the increasing net interest income resulting from the mandated decline in our retain portfolio. The portfolio balance shrinking by nearly $20 billion during the quarter to $321 billion. This decline in balance combined with the decrease in the net interest deal on our investments, which is naturally happening as the portfolio of mix is being intentionally shifted away from less liquid assets and towards more liquid ones resulted in adjusted net interest income of $671 million for the second quarter, down from $882 million in the first quarter. Taken together, our solid performance in the second quarter is enabling us to return an additional $933 million in dividends to the US Treasury in September, bringing the cumulative total to $99.1 billion or nearly $28 billion more than we've received in draws.
Finally because I've been asked about this in past quarters, I want to comment briefly on what we are doing to reduce the likelihood of a treasury draw. We've said we are looking at many ways to do so and we'll implement them as the PSPA's capital buffer decline. So far this year, we've done several transactions to that effect. These transactions have the impact of increasingly assets which are fair value and thus we have reduced somewhat mismatch against our fair value derivatives. The impact of this can be seen on page 23 of our financial results supplement where we disclosed our GAAP interest rate sensitivity measure. This measure declined almost $300 million or about 20% during the second quarter, reflecting both natural reduction that sensitivity which accompanies declining interest rate as well as the completion of the particular transactions we executed. We continue to actually explore efficient methods reduce the likelihood of withdraw and we will inform you them during our quarterly updates.
Let me now turn to our work in building a better Freddie Mac and in turn a better housing finances system. I highlight our progress in our three lines of business. First, Single-Family business which is our largest. Purchase volumes were strong this quarter, up 32% partially driven by the best spring home buying season in a decade. Through these purchases we funded nearly 392,000 single-family homes. Importantly, we are managing this expansion in a responsible and sustainable way. Our single-family serious delinquency rate declined to 1.08% in the second quarter, down 45 basis points from the same quarter last year and this is the lowest level since August 2008 guess before conservative shift. Our new core book of business is strong and profitable. It's now 69% of our portfolio with HARP and other relief refinances loans making up an additional 17%. An important focus for us in this our biggest business volume is our work to provide better support to our seller service or customers and thereby the market. So we are particularly excited that Freddie Mac's Loan Advisor Suite officially launched last month. Loan Advisor Suite is a set of fully integrated software tools designed to give lenders a way to originate and deliver high quality mortgages through a less costly process and with greater certainty. We are taking a consultative approach this rollout, working hand in glove with our customers to help them integrate these leading edge new software tools into their own operations and systems to make their businesses better.
Of course our community mission is also core aspect of what we do. In support of this priority, we helped another 17,000 struggling borrowers avoid for closure. In addition, we continue to fund record levels of mortgages for first time homebuyers. 42% of our non-refi purchase volume in the second quarter was the fund loans to first time homebuyers. This is the highest percentage in 10 years. In our previously announced partnerships with Quicken and with Bank of America, which are aimed at increasing access to credit for underserved borrowers are meeting if not exceeding our expectations.
However, limited housing inventory in many geographies and resulting rising house prices continue to challenge low and moderate income borrowers. An issue mortgage product alone will not solve. We are also working on a post HARP offering with the FHFA as that program is currently scheduled to sunset soon. Given that we revised our interest rate outlook downward with brexit and are now predicting the 30 year fixed rate mortgage to close the year in the 3.6% range. This will be an important offering to continue.
So, overall we are continuing to build the better business with our customers who as we work with them to expand opportunities for borrowers. It's important to note that we are doing this work in a taxpayer friendly manner to our leadership in credit risk transfer. Credit risk transfer is changing the way a significant portion of the US housing market is funded. And I am proud of our leadership in shifting risk away from taxpayers in an economically efficient way. While providing new investment opportunities for investors and strengthening the mortgage markets overall.
We achieve this significant milestone in this program through the end of the second quarter by transferring to private capital sources as giving a portion of the credit risks and more than $500 billion of single-gamily loans cumulatively since we created the market in 2013. This represents nearly $22 billion in total loss protection for taxpayers. We are proud that our leadership in this space is continued to be recognized. For the second consecutive year our STACR debt notes have been named RMBS yield year by Global Capital magazine. Freddie Mac also won top honors for best overall securitization issuer and best RMBS issuer.
We are also continuing to actively chip away at our legacy book to sales and securitizations of our less liquid assets. Through these efforts we've reduced single-family legacy assets by $63 billion since 2013. And therefore the legacy book is now just 14% for single-family portfolio.
I'll now turn to our Multifamily business. We continue to provide high levels of funding to the multifamily market in the second quarter, financing more than 148,000 units of rental housing while at the same time working to improve our customers experience in doing business with us through new process innovations and strong relationship building. And we continue to lead this market in multifamily securitization and also credit risk transfer. We transfer the credit risk on quarterly record $15 billion of multifamily loss, a well know K-Deals to which lay off the large majority of non catastrophic credit risk to private capital market have now passed $150 billion issuances since the program's inception.
We also introduced several innovations to our multifamily securitization offerings this quarter. For example, we launched our multifamily structure credit risk or SCR pronounced score debt notes. Scores notes a portion of the credit risk is transferred from mortgage securities as opposed to the more traditional mortgage loans we have in a reference pool to private capital investors. We also launched a new series of K-Deals the KW series which were solely backed by workforce housing loan, i.e. loans are multifamily properties where rent is affordable to the majorities low and middle income household in a geographic region. KW-Deals are designed to help us target investors with more specific collateral pools. Importantly, nearly 90% of the rental business we are funding is affordable. That includes many type of underserved segment such as manufactured housings, student housing and senior rental units both independent and assisted living. And of course as has been the case for some time now, our multifamily delinquency rate remains near zero.
I also want to say a few words about our Investment business. We continue to make marked progress in the mandated reduction of our retain portfolio. We've actively reduced the repaying portfolios less liquid assets, most of which have been impaired by more than $80 billion since 2013. Liquid assets are now the majority of our assets. As another example of innovation, we introduced the new pilot senior subordinate structure to sell much of the credit risks of season loans, most of which represent defaulted loans which have begun to re-perform after modification. And we continue to look for other economically viable options to actively reduce the portfolio especially the less liquid assets in economically efficient ways.
Finally, underlying all these effort is our work to improve the competitiveness of the company and the industry. Improving customer service, developing tools for our customers to improve their operation, enhancing our risk management capabilities, improving return and risk we take with taxpayers support and also working towards the common securitization platform and thereby a single security. To name just a few the many initiatives we have here.
Let me now end. Thank you for listening. I'll now open it up to questions.
We will take our first question from Joe Light with Bloomberg.
Good morning. Thanks for taking the question. On the structure transactions that you referenced to deal with the derivative issue. Can you talk a little bit about I guess whether these transactions bear some sort of economic cost for Freddie? I guess basically whether you are having to give up any income or increase your expenses to deal with the GAAP accounting mismatch.
Yes. The transactions are basically came at negligible almost un-measurable reduction in income. They largely relate to taking loans we have and pack them into CMOS, selling parts off and keeping the rest, prices optically attractive for doing this in the marketplace for a variety of reasons. And therefore the mix of our assets moved a bit more towards fair value reducing the mismatch with the derivative fair valuing which is really net liability side position. So the answer is they were -- I won't say a freebie but almost a freebie.
There are no other questions.
Fine, okay. I'll turn it back to Don Layton.
Okay. Thank you again. Let me wrap up by saying we are proud of the consistent business progress we've been making and building a better Freddie Mac. We feel good about the solid first half of 2016 and the strong momentum we have going into the second half of the year. I hope you all enjoy the rest of the summer. And I look forward to updating you on our progress in three months. Thank you.
Thank you, everyone. That does conclude today's conference. We thank you for your participation.