Why is Freddie Mac Down Despite Impressive Q3 Earnings? - Analyst Blog

Federal Home Loan Mortgage Corporation ( FMCC ) or Freddie Mac's third-quarter 2014 results reflected its 12th consecutive quarter of positive earnings with net income of $2.1 billion, up from $1.4 billion in the prior quarter. Results were positively driven by higher income from legal settlements associated with private label securities (PLS) and reduced derivative losses.

However, shares inched down 1.36% to close at $2.18 as deterioration in loss severity led provision for credit losses compared with benefit recorded in the prior quarter. Moreover, higher expenses were also a concern.

Freddie Mac reported pre-tax income of $3 billion, up 50% sequentially.

Performance in Detail

Net interest income increased 5.7% sequentially at $3.7 billion. Net interest yield stood at 0.77%, up 4 basis points sequentially. Lower funding costs aided the increase. Derivative losses were $0.6 billion, down from $1.9 billion in the prior quarter, mainly due to reduced losses on the net pay-fixed swap portfolio as mostly long-term interest rates rose.

Further, non-interest income came in at $0.8 billion compared with loss of $1.4 billion in the prior quarter. Non-interest expense increased 14.3% from the prior quarter to $0.8 million.

Freddie Mac reported provision for credit losses of $0.6 billion in the quarter, compared with a benefit of $0.6 billion in the prior quarter. The provision resulted from deterioration in loss severity.

Furthermore, segment-wise, on a sequential basis, Single-family Guarantee and Multifamily segments recorded a fall of 66.7% and 20% in earnings, respectively, while the Investments segment reported a significant rise in earnings.

Based on net worth of $5.2 billion, Freddie Mac's dividend obligation to the Treasury will stand at $2.8 billion in Dec 2014. Notably, including this dividend obligation, the company's aggregate cash dividends paid to the Treasury will total $91 billion as compared with cumulative cash draws of $71.3 billion received from the Treasury through Sep 2014.

Further, since Jan 1, 2009, Freddie Mac provided $2.4 trillion of liquidity to the mortgage market, which helped fund 8.1 million refinancings, 2.5 million home purchases and 1.8 million units of multifamily rental housing. Moreover, the company helped about 1 million borrowers to avoid foreclosure, which included 94,000 in the first nine months of 2014.

Credit Quality

As of Sep 30, 2014, Freddie Mac's new single-family book (loans acquired after 2008, excluding HARP and other relief refinance mortgages) was 58% of the UPB of Freddie Mac's single-family credit guarantee portfolio, while HARP and other relief refinance loans accounted for 20% of the portfolio.

Further, Freddie Mac's 2005-2008 legacy single-family book continued to decline. As of Sep 30, 2014, the book represented 14% of the portfolio and recorded 83% of the company's single-family credit losses during the first nine months of 2014.

Recent Settlements

During third-quarter 2014, Freddie Mac and the Federal Housing Finance Agency (FHFA) entered into agreements with a number of firms for settling litigations related to Freddie Mac's investment in certain PLS. These settlements increased the company's pre-tax income by $1.2 billion in the quarter.

Further, Freddie Mac entered into deals with many of its sellers to resolve certain representation and warranty claims in lieu of one-time cash payments. Notably, these agreements had a minimal effect on the results.

Our Viewpoint

Though Freddie Mac suffered losses during the crisis of 2008-2009 and had to be bailed out by the government, it managed to turn itself into a profitable organization supported by stable recovery in the housing market.

We believe that Freddie Mac's recent settlements will yield profitability in the coming quarters. Moreover, higher interest income was the other positive. However, elevated non-interest expenses were a concern.

Currently, Freddie Mac carries a Zacks Rank #3 (Hold).

Competitive Landscape

Federal National Mortgage Association ( FNMA ) or Fannie Mae reported third-quarter 2014 net income of $3.9 billion, down 55.2% year over year. The huge earnings decline led to negative market sentiment despite the government backed mortgage financier delivering its 11th consecutive quarterly profit.

Some companies in the same sector worth considering include Home Loan Servicing Solutions, Ltd. ( HLSS ) and PennyMac Financial Services, Inc. ( PFSI ). Both carry a Zacks Rank #2 (Buy).

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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