Federal Home Loan Mortgage Corporation

Sharon McHale - VP Corporate Communications & Marketing Don Layton - Chief Executive Officer Jim Mackey - Chief Financial Officer Bill McDavid - General Counsel

Joe Light - Bloomberg News Denny Gulino - Market News International Austin Kilgore - Source Media

Thank you. Good morning, everyone, and thank you for joining us for a discussion of Freddie Mac’s first quarter 2017 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 Form-10Q filed today.

Freddie Mac’s executives may also discuss non-GAAP financial measure. For more information about these measures, please see our earnings press release and related materials which are posted on the Investor Relations section of our website, at 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 can ask questions. This call is being recorded and a replay will be made available on Freddie Mac’s website shortly.

We ask that this call not be rebroadcasted or transcribed. With that, I’ll now turn the call over to Don Layton, Freddie Mac's Chief Executive Officer.

Good morning, and thank you for joining us for our quarterly update. I'll spend my time covering two areas, first I'll discuss our financial results and second I'll touch on our progress in growing our business.

Reducing risk and building a better housing finance system. Let me get right to the financials.

It was a very solid quarter for earnings and the numbers are starting to speak for themselves. I'll hit the highlights and let you read the details in our press release and 10-Q.

This morning we reported net income and comprehensive income of $2.2 billion, the first insight into this figure is that market moves and interest rates and spreads were minimal in the quarter at just 1/10 of the $1 billion. Such a low impact at our results is only happened one other time in almost the last three years.

As a result the fundamental business strengths of the transformed Freddie Mac are now more clearly showing through. One of the best measures of this is that the level of the guarantee businesses we have on our books including both single family and multifamily is growing.

In the first quarter it increased by $30 billion and it grew by 6% over the past year. The best measure of the revenue produced by this growing guarantee book is as we have discussed in the past adjusted guarantee fee income.

In the first quarter adjusted guarantee fee income was $1.6 billion. This is down from the fourth quarter of 2016, but up from the year ago quarter.

I know that this number has definite market sensitivity to it just beyond the general business cycle. Simply put some single-family guarantee fees are paid to us upfront rather than per annum, expected life by which we amortized those upfront fees into revenue changes as refinancing activity goes up and down.

When refinancing is high the amortization is faster and so our earnings rise, when refis are being done at a lower rate the amortization is slower and so our earnings fall. Putting aside that indirect market sensitivity, adjusted guarantee fees have had an underlying weight of growth, based upon the size of the guarantee book growing which I just reviewed.

Adding to that guarantee fees are new single-family business have been and continue to be higher than the average of those amounts being paid-off, natural this creates another upward bias in revenues as well. The investments business can similarly be reviewed in terms of its balance sheet and revenues.

Our investments balance sheet is dominated by the retained investment portfolio which we formally call the mortgage related investments portfolio and it is mandate to be reduced by the U.S. Treasury and the FHFA our regulator and conservator.

As a result the total portfolio was $383 billion down 9% from the previous year. I note that the retained portfolio completed of it dropped by 14% over that time to $291 billion.

Adjusted net interest income, the interest spread generated from our investment activities, is the primary source of revenue generated by the investment portfolios. It was $1.20 billion in the first quarter, while we expect that this income stream will decline overtime due to the mandated shrinkage, our skilled investments professionals have ameliorated the rate of that decline.

In fact, adjusted net interest income was down only 6% from the first quarter of 2016. Again, I want to note our first quarter results experienced a minimal impact for market moves which is only happened one other time in almost the last three years.

By comparison we've already had major moves in the second quarter. I've frequently discussed that the biggest component of the volatility and our GAAP results stem from our use of derivatives to hedge interest exposures.

With consequent large timing differences between our GAAP financial statements and the underlying business economics. In addition to undertaking certain financial transactions to ameliorate the sometimes-large impact of this timing difference, we have had an objective to permanently get our GAAP financials more in line with the underlying business economics.

We took a big step forward in that regard by implementing hedge accounting with respect to certain mortgage assets early in February. With this adoption of hedge accounting, we expect quarterly income variability for movements and interest rates to lessen significantly, so our strong business fundamentals should become more routinely evident in the financial results moving forward.

We saw this reduced variability inter-quarter during the first quarter and continue to see it during the major moves so far in this second quarter. As a result of our strong business fundamentals we are scheduled to return another $2.2 billion to tax payers.

Bringing the total dividends paid to more than $108 billion over 50% more than we have drawn. Let me now turn to how we are growing our business.

Reducing risk and building a better housing finance system. I'll start with how we are responsibly growing the guarantee businesses.

Let's start with single-family. The single-family guarantee book grew by $24 billion in the first quarter to $1.8 trillion, and was up more than 4% from the first quarter of 2016.

This growth was driven by solid purchase volume of $86 billion, despite a drop-in origination caused largely by higher interest rates and also by the tight inventories supply of homes for sale, which has been much reported in the press. We expect originations to be down this year due to these higher rates and resulting lower refi volume.

Though interest rates have dropped a bit recently, they still stand roughly 50 basis points above the lows of last summer. Given that it's more important than ever that we deliver greater efficiency in certain fee for our customers in order to help them reach more borrowers and reduced cost in this challenging market environment.

One very specific example how we helped during the quarter was by automating the assessments of borrowers with our credit scores. These enhancements to loan advisor suite, our new integrated set of loan production tools will help our lenders serve more potential home buyers including first time home buyers and borrowers who may previously have been shut out of home ownership.

This is a good example as well of responsibly and sustainably increasing access to credit. We also regionally begin offering lenders collator rep and warranty release [ph] on loans delivered us through loan advisor suite.

These enhancements give lenders more certainty around the business they are doing with us, which ideally will translate into greater usage of our credit box. Let me now switch to the multifamily business, with the guarantee portfolio increased by 6 billion during the quarter to 164 billion.

It is up by a very strong 28% from the first quarter of 2016. Multifamily purchase volume remains strong at 13 billion for the quarter, while this volume is less than last year's first quarter record level reflecting some seasonality outstanding loan commitments increased in the first quarter and we expect full year volume to be consistent with last year as demand remains strong.

And just as we are doing for our single-family customers we are continually working to find ways to help our multifamily customers succeed in a competitive market. As an example, our Green Advantage Financing initiative, which lowers the cost of borrowing for qualified properties such as workforce housing built before the year 2000, has been doing extremely well.

We provided 3 billion in Green Advantage Financing during the first quarter, supporting energy efficiency improvements in more than 30,000 rental units. [Indiscernible] tools like Loan Advisor Suite and Green Advantage benefit not only our customers, but Americas families as well.

Our commitments to deliver on our mission to responsibly increase access to credit and specifically to increase affordable lending is also showing results. I can tell you that the people who work at Freddie Mac and by the way are very much driven by our mission to help people get into good homes, are very proud of that fact, and our single-family business for example the percentage of new business by serving first time homebuyers are already at a 10 year high, continued to increase during the quarter.

The percentage of borrowers making down payments of less than 20% is also increasing, reflecting our work with our customers and the industry to better educate borrowers about their options and enable loans down payments lending on a responsible basis. Nearly a quarter of all the loans we purchased last year with the borrowers putting down less than 20%.

In the multifamily business our focus is on supporting working families' earnings at or below 100% of their area median income. The vast majority of our purchases support this goal.

Our work to support renters or homebuyers in the nation's underserved markets will continue to be a focus for us. As an example, our drafted Duty-to-Serve plan which we recently submitted to FHFA and will be available for public comment, lays out how we intend to lead the industry in helping families in three important underserved markets, manufactured housing, world housing and affordable housing preservation.

Before I move on from our guarantee businesses I want to make a quick point. Even as we expand access to credit the credit quality of our book to business remains very strong.

The overall single-family securities delinquency rate declined another eight basis points in the quarter to 0.92% falling below 1.00% for the first time in nearly a decade. Our core, that is post 2008 book of business, through the 74% of our credit guarantee portfolio during the same period, up 6% percentage points from the same period last year.

The series delinquency rate on this new book, the core book is just 19 basis points, reflecting quality underwriting and the impact of house prices rising since 2009. And as 0.03%, yes 3 basis points, the delinquency rates are our multifamily portfolio remained near 0.

Let me update you on some other ways we are reducing taxable tax payer exposure to risk. Innovation is at the heart of these efforts.

As I mentioned earlier we continue to shrink our risk year legacy book of business. Our focus here is on liquid assets almost all of which are impaired.

We actively reduced less liquid assets by additional 5% or $6.8 billion during the quarter. Liquid assets are now 51% of the mortgage rated investment portfolio compared to 46% just a year ago.

Important as this work is, it is also our leadership in credit risk transfer that is enabling Freddie Mac to fundamentally change the way the residential mortgage market is funded. We have now transferred a portion of the risk and more than $725 billion in single-family mortgages, providing more than $28 billion of loss protection for tax payers.

Our conservative score card mandate is to transfer risk on 90% of eligible loans. Those with terms greater than 20 years and LTVs greater than 60% and we're exceeding that measure.

The impact of credit risk transfer is even more pronounced in the multifamily business, where we've now transferred the vast majority of the risk on more than 193 billion of multifamily loans. And we are continuing to innovate in multifamily.

For example, with the recent introduction of our new KT certificates we are now transferring a portion of the interim risk we hold to multi-family loans before they are securitized into our K-deal [ph] offerings. We are maintaining our focus in innovation and credit risk transfer not only by introducing new offerings by KT certificates, but also by refining our existing offering to make them more attractive to investors.

Earlier this year for example we enhanced our flagships stacker offering by restructuring several of the tranches, a change that was very well received by the market. I'm glad to say that demand for these stacks of securities continues to be very strong.

In fact, just month we priced our largest deal to date on very attractive terms. Taking it together our actions are helping to build a better Freddie Mac and better housing finance system for the future.

A company and a system builds on innovation for the market, greater efficiency for lenders, reduce risk for tax payers and responsible lending for more and more family. With that let me wrap up by saying that we are continuous to be a great deal of momentum across the company.

The management team and I feel very good about Freddie Mac's transformation and the progress we have made. I'll now open it up to your questions.

I was wondering if you could walk through how much of the low, I guess, very low impact on earnings continue rates had to do with the transactions you have been doing to mitigate that and the change to hedge accounting as opposed to this the relatively benign or flat rate environment over the last quarter?

I'll start off and then I'll ask our CFO Jim Mackey to comment. We implemented hedge accounting and that’s the main thing going on now.

These transactions we did to ameliorate the risk last year are largely running off at this point. Hedge accounting was implemented on February 2, inter-quarter views insiders saw as advertised and -- as obviously advertise.

As explained in our 10-Q we expected to reduce the volatility with respect to interest rates earnings roughly 50% at this point. The interest quarter swing showed us it was doing at least 50%, it just happened that the gross and net were very small numbers at the end of the quarter.

so it was a negligible impact that was just happened stances to where the quarter ended. Jim, anything to add?

Nothing to add. It would have been 50% [ph] had we had a larger rate move.

[Multiple Speakers] And in this quarter where there have been swings, we are seeing it deliver at least that 50% reduction, although where the quarter ends up, we won't say.

And it all depends on how the curves move. Not just rates going up and down, but the shift in the curve.

Though it’s hard to put a number on it exactly.

Is there any operational consequence at all other than just an increased risk of a treasury draw as we get closer to this 2018 date, when the capital reserve disappears? Is there anything you have to do to get ready or compensate for or whatever?

So let me sort of rephrase your question, hopefully I get it right. Basically, I think you are asking us, given the shrinking capital reserve as called for in the -- capital buffer as called for in the PSPA, which was $600 million this year and zero next year, are we doing things differently?

Is that your question?

Yes, do you have to do anything differently or will you have to do anything differently as you get closer?

Yes, we don’t have to do anything what we are doing is sort of the same thing we would do if we were an independent company with normal circumstances. We are trying to get -- the only thing we are doing is trying to get our GAAP accounting more in line with the economics of the business.

The underlying business of Freddie Mac is very annuity stable oriented. But the accounting is not always friendly for that, so we are doing what we can to have the underlying economics come through hedge accounting is an example of that.

I would do hedge accounting just as a regular company to show our underlying economics to the marketplace. Beyond that there is not much to do about it, it just exists and it will be what it would be.

We are running our business on behalf of our customers and the tax payer, trying to do so and nice sustainable and regular way.

I'm wondering that -- you mentioned that the -- I can't remember exactly the percentage, but a large -- decent chunk of home buyers are putting less than 20% down and I know you guys have done two different things with the Loan Advisor Suite to kind of get a little bit more insight and data into the underwriting process and I was just curious how you guys think about the changes coming later this year with the credit reports having certain leans removed from the credit reports, are you guys concerned at all about credit reports and credit scores maybe getting a little less accurate and what do you do to kind of mitigate whatever concerns exists there?

Okay, let me make two sets of comments, one more on the first part of your question and one more on the second. Under FHFA direction and very congenial to our culture here we are trying to figure out how to responsibly expand access to credit.

One way this shows up is more home buyers who are using down payments less than 20%, but everything needs proper credit requirements, means they have compensating factors that work to their favor in terms of income or other issues. In addition, I just want to remind you that for any LTV greater than 80% we are required to have someone else cover the exposure in one of three ways listed in our conventional charter, by far the most common is getting mortgage insurance.

So we have that, if you will, belt suspenders as well. In terms of the particular item you are mentioning, it is something that was studied by our single-family credit area in terms of change in some reporting of leans not being there anymore, it is very, very small, it is not a material item in our credit picture.

Okay, thanks.

All right, again thank you for joining us this morning. I always look forward to sharing our progress with you, and helping into better understanding how the serving lenders, borrowers and renters and doing so in a very tax payer friendly manner.

Talk to you next quarter.