Thanks to Value Investor Insight co-editor and Value Investing Congress co-promoter Whitney Tilson for bringing my attention to the wild exchange between Bank of America (BAC) analyst Robert Lacoursiere and Freddie Mac (FRE) officials on the company’s conference call yesterday:
Lacoursiere: I just wonder if you could just help me understand how you come up with these — the valuations for the LIA loans. [LIA loans are losses on loans purchased.) There’s obviously not a market. So what are you using, like a level two approach and where do you get the inputs from?
Patti Cook, Freddie Mac’s chief business officer:Actually, we do get LIA marks from the street and you’re right, and part of that is probably reflected in the price. It is an illiquid market. It’s certainly not trading as many of the other securities that we own trade. But we do go to the street for an independent mark.
Lacoursiere: But they never actually trade. You don’t actually sell these things, right. You’re just asking them to quote you a figure, right.
Cook: Right. You’re on to a good point, Robert. Because I think the same thing is in evidence when we price the overall GO. You know, if you think about it, our — the mortgages that we’re guaranteeing in our G fee business really don’t trade in securitized — in a triple A senior sub sort of structure. So even there, the fact that we take that structure, we go to the market and we ask for a price on something that really doesn’t trade I think supports the notion that the uncertainty in the credit risk premium that’s embedded in those marks is likely to overshoot in a cautious credit environment.
Here’s where it gets interesting:
Lacoursiere: That is precisely my point. I’m wondering why you have to rely on those quotes when there’s no market. Why can’t you do a level three approach and put your own assumptions in like other institutions do?
Buddy Piszel, Freddie’s CFO: We have been there in the past and the feedback that we have received from our auditors is the market is a more reliable source of pricing and accordingly, even in thin markets, that should be our first line of defense, whether it contradicts our models or not. And we have — since we made this change, we’ve only looked to the market wherever possible and we’ve always been able to get market prices. Whether we like them or not, they are out there. And if they’re out there, we’re using them to measure. Because the accounting literally says that you’re suppose to use — that what someone would pay you to take the obligation off your hands and if there’s a market price out there, that is an indicator of the price that you would have to pay to have it taken off your hands.
If I’m interpreting this correctly, Lacoursiere is suggesting that given that the market for much of the stuff is likely garbage anyway, Freddie should just treat it as such on its books. The CFO responds by passing the buck to the auditors and then pretty much reiterates what Cook said about getting prices from the Street.
And with that Lacoursiere dares to go into sacred territory and, in a public assembly, bring up the elephant in the room:
Lacoursiere: If I could just bother you with one follow-up, if they’re quoting — if these institutions are quoting you those prices, are they not obligated to reflect those valuations on their own positions on their own books?That’s right, don’t look at that man behind the curtain. Dominoes, anyone?
Piszel: That’s an interesting question but we’re not going to go there.