Freddie Mac lost $2.5 billion in the fourth quarter, forcing the company to cut dividends by 50 percent, issue $6 billion in preferred stock, and reduce the size of its loan portfolio to meet regulatory capital requirements.
Declining long-term interest rates required Freddie Mac to recognize a $2.3 billion reduction in value of derivative investments used to hedge against interest-rate changes. Provisions for credit losses on bad loans and sales of real estate-owned properties totaled $912 million, also taking a toll on the company’s bottom line, the company said.
But fees the company made from securitizing and guarantying mortgage loans during the fourth quarter were up 10 percent from a year ago, to $698 million.
Over the long run, Freddie Mac Chief Executive Officer Richard Syron said he expects “robust growth” in the guarantee business, along with better returns resulting from tightened underwriting standards and increased fees.
“It is essential to note that a significant portion of our losses were not economic, but the result of accounting conventions,” Syron told investors in an introduction to the company’s annual report. “Mark-to-market” accounting requires the company to anticipate losses that may not materialize, Freddie Mac’s CEO said, and new business the company is taking on today will “generate attractive returns tomorrow.”
But before that happens, Freddie Mac said it expects credit losses, including charge-offs and losses on sales of real estate-owned properties, to more than quadruple this year, to $2.2 billion, and rise again in 2009 to $2.9 billion. Fourth-quarter credit losses totaled $236 million, up from $126 million in the third quarter and amounting to nearly half of the $499 million total for the year.
Mounting losses at Freddie and sister company Fannie Mae are expected to limit their acquisitions of new loans — including “jumbo light” loans Congress and the Bush administration have authorized the companies to buy and guarantee until the end of the year.
Federal regulators said Wednesday they are lifting caps that limited Freddie and sister company Fannie Mae to holding no more than $1.5 trillion in mortgages and mortgage-backed securities as investments
But stiffer capital requirements — adopted in 2004 after accounting and management scandals that forced both companies to restate several years of earnings — will remain in place for now, the Office of Federal Housing Enterprise Oversight said (see Inman News story).
The stiffer requirements mandate that Fannie and Freddie maintain capital levels 30 percent above statutory minimums established by Congress. The requirements have forced the GSEs to reduce, rather than grow, their loan portfolios in recent months.
Although the caps to be abolished March 1 permitted the GSEs to grow their loan portfolios to $742 billion by the end of last year, Freddie instead slashed its retained investment portfolio from $732 billion last August to $717 billion at the end of January. Fannie made similar reductions, trimming its loan portfolio from $732 billion in October to $721 billion at the end of last month.
Syron said backing the bigger loans allowed under the temporary increase in the conforming loan limit — the GSEs will be permitted to buy mortgages as large as $729,750 in high-cost areas until the end of the year — “will pose a particular challenge for us” because those loans will require more capital.
Freddie reported today that its regulatory core capital totaled $37.9 billion at the end of the year — $11.4 billion above the previous statutory minimum, but a less comfortable $3.5 billion cushion above the stiffened requirements put in place by OFHEO in 2004. Fannie Mae had a $3.9 billion in surplus capital above the OFHEO-directed minimum.
After Fannie reported a $3.6 billion fourth-quarter loss Wednesday, Moody’s Investors Service announced that it had placed the company’s “B+” bank financial strength rating on review for a downgrade, saying the loss “exceeded our expectations and represents a significant deterioration of surplus regulatory capital.”
Freddie Mac’s “A-” bank financial strength rating remains under review for possible downgrade, Moody’s said in a separate announcement.
Moody’s said the rating “measures the likelihood that a financial institution will require financial assistance from third parties, such as the government or shareholders,” but not the probability that they would actually receive it.
Moody’s analysts said their concerns about Fannie Mae were “partially mitigated” by OFHEO’s promise to discuss a gradual reduction in the requirement that the GSEs maintain capital at levels 30 percent above statutory requirements. Eliminating the requirement would reduce Fannie Mae’s capital requirements by $9.6 billion, Moody’s noted.
In the meantime, Fannie could raise capital by reducing its mortgage portfolio and reducing or eliminating its dividend, Moody’s analysts said, and by tightening underwriting standards and increasing guarantee fees.
By buying mortgages and mortgage-backed securities and holding them in their investment portfolios, Fannie and Freddie reduce the cost of borrowing by providing liquidity to mortgage markets. But the GSEs also provide liquidity by bundling up loans that meet their underwriting standards and selling them as guaranteed securities to other investors.
Because Fannie and Freddie will be required to package the new jumbo light mortgages in a separate market than conforming loans, investors may demand higher returns. That means borrowers may not see a large reduction in the roughly 1 percent spread between interest rates on conforming and jumbo loans, a major objective of lawmakers and the Bush administration in giving the GSEs the green light to venture into jumbo loan territory (see story).
