Freddie Mac Profit Slides on Derivative Losses

Wall Street Journal

By JOE LIGHT and MICHAEL CALIA

Updated Feb. 19, 2015 11:27 a.m. ET

Mortgage-finance company Freddie Mac will send the U.S. Treasury $900 million in March, after posting a fourth-quarter profit that declined steeply from a year earlier.

The company said that its fourth-quarter net income was $227 million, down from $8.6 billion in the same quarter of 2013. The profit was driven by interest income of $3.6 billion and derivatives losses of $3.4 billion.

Still, the three-month period ended Dec. 31 was the 13th consecutive quarter in which the firm showed a profit.

The derivatives losses were also not as serious an issue as they appeared. Freddie uses derivatives to hedge its portfolio’s exposure to rising interest rates. For accounting purposes, the company marks the derivatives to the market price, even as it carries many of its hedged investments at cost.

Because of that mismatch, when rates fall, as they did late last year, the derivatives can show a loss, even though the effect should even out over time.

Freddie, along with mortgage-finance firm Fannie Mae , was put into a conservatorship by the U.S. government in September 2008 after crisis-era losses.

Freddie received about $71.3 billion in support from the Treasury. After the expected March payment, Freddie will have paid back $91.8 billion.

Freddie doesn’t make loans, but buys them from lenders, wraps them into securities and guarantees to make investors whole if the loans default.

As policymakers continue to debate the future of the companies, Freddie and Fannie are slowly reaching what could be described as a normal operating environment. Although the companies’ profits had been partly driven by large post-crisis settlements with lenders on crisis-era mistakes, much of that is behind them.

“The ’Great Recession’ is passing through. We’ll have fewer giant swings in credit losses…There are a declining amount of special items,” said Freddie CEO Donald Layton . “We expect less and less of that kind of stuff to deal with.”

Likewise, as home prices have risen and borrowers’ credit quality has improved, Freddie has seen fewer defaults. Freddie said its single-family serious delinquency rate at the end of the year was 1.88%, its lowest since January 2009.

Lenders for the past few years have been loath to make loans to borrowers with anything less than pristine credit, in part because of the steep penalties that they faced from Fannie and Freddie after the financial crisis.

Late last year, the companies reached an agreement with lenders clarifying their liability for making loan mistakes in an effort to entice lenders to make loans to creditworthy borrowers with worse credit scores and lower down payments.

Mr. Layton said that on average, lenders have been moving to offer more loans to such borrowers, though some have been quicker or slower to lessen the requirements.

Write to Joe Light at joe.light@wsj.com and Michael Calia at michael.calia@wsj.com

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