Federal Home Loan Mortgage Corporation

Jeffrey Markowitz - Senior VP, External Relations and Corporate Communications Don Layton - Chief Executive Officer Jim Mackey - Chief Financial Officer Bill McDavid - General Counsel

Joe Light - Bloomberg News Bonnie Sinnock - National Mortgage News

Good morning, everyone, and thank you for joining us for discussion of Freddie Mac’s second quarter 2017 financial results. We are joined today by the company’s 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 10-Q filed today. Freddie Mac’s executives may also discuss non-GAAP financial measures.

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 re-broadcasted or transcribed.

With that, I’ll now turn it over to Don Layton, Freddie Mac's CEO.

Good morning and thank you for joining us for our quarterly update. I know everyone has the busy schedule, so I will keep this short and leave more time of questions.

First I'll discuss our financial results and strong business fundamentals, but I only want to do that briefly. What I really want to focus on is how are results fit into the bigger picture of what’s happening at Freddie Mac in conservatorship.

I think that’s the real story here, how we have transformed Freddi Mac from a GSE business model now widely regarded as having certain fundamental flaws and into a well-run competitive financial institution that no longer looks to unduly exploit those flaws and how that transformation is helping us in turn transfer US housing finance worth a better as well as helping us better deliver on our distinct mission to provide liquidity, stability and affordability to the nations mortgage market. Let’s begin with the results.

Clearly, it was another very solid quarter for earnings. I’ll hit the highlights and let you read the details in our press release and 10-Q.

This morning, we reported net income of $1.7 billion and comprehensive income of $2.0 billion. As I have often noted, we focused mostly on comprehensive income while in conservatorship.

Again, like I said last quarter, the numbers are speaking for themselves. There was very little market-related impact on our results in this second quarter.

This was partly due to market spreads remaining relatively unchanged during the quarter, but more importantly, our adoption of hedge accounting earlier this year is paying off. It is helping to offset the accounting losses which can arise from changes in interest rates.

So that net of the hedging in this quarter we had relatively little impact of this on earnings, despite a downward in rates. Just to give you some specifics, hedge accounting helped us reduce our hit to our GAAP earnings by almost $400 million pretax in the second quarter.

In the absence of large market-related items, our business fundamentals really shined through, and they are the strongest in nearly a decade. I think of these fundamentals in three buckets: growth in guarantee portfolio, credit quality and tax payer risk.

First, let me start with the growth of our guarantee portfolio. Please remember that the guarantee businesses were in single-family and multi-family are why we exist and why we were targeted by Congress.

Our total guarantee book was just shy of $2 trillion in the second quarter, up 6% from a year ago. The single-family guarantee portfolio is up 4% from a year ago.

The multi-family book is also up, ending the quarter at $174 billion, an increase of 23% from a year ago. Strong second quarter multi-family purchase volume of $14 billion helped to drive this increase, and we expect to have another record year of funding rental properties.

The growth in the dollar amount of our guarantee business is core to driving a robust level of revenue growth over the long term. The best measure of this revenue growth is adjusted guarantee fee income, which is strong again this quarter at $1.7 billion.

While this revenue was cycled higher or lower as front-end fees get amortized into income faster or slower with the level of refinancing, it will tend to grow along with the underlying size of the guarantee book over the long term. Now let me turn to our credit quality, another very good story.

Our single-family delinquency rate is at the lowest since early 2008, decreasing 23 basis points from a year ago to 0.85%. It is unclear exactly what the very long-term stable level of this number should be, but we're clearly getting closer to it.

These numbers indicate that we are now expanding access to credit responsively. The single-family core book continues to grow profitably and is now a full 75% of the credit guarantee portfolio.

Those are the loans originated post 2008, excluding HARP and relief refinancing loans, added in those HARP and relief refi loans, and that is 89% of the book in total. This shows how much the financial crisis is behind us.

At the same time, we continued to reduce the legacy book, the pre-2009 loans. It's now 11% of our total portfolio compared to 40% a year ago, and it's not just running off.

We are creatively reducing it with valuated disposition transactions that are good value for the taxpayers who support us. The multi-family delinquency rate remains at essentially zero.

That has been true for long time and continues as strongly as ever. Last, let me talk about how our business model poses much less risk to tax payers.

We believe our underwriting is safe and sound with the properly defined credit box. So we're putting people in homes they can afford now and for the long term.

We pioneered GSE credit-risk transfer programs in today's single-family and multi-family businesses, which is changing the way the mortgage markets are being funded. In multi-family, heavy credit risk transfer is already deeply entrenched in our business model.

In the single-family mortgage market, I’d say we're midway through a roughly decade long journey in developing credit risk transfer to be all that it can be as we continue to make substantial progress in developing this important asset class. At the end of the second quarter, 33% of the single-family credit guarantee portfolio at some form of credit-risk transfer coverage.

Our transactions are attracting a growing number of investors. We now have more than 220 unique investors, and the deals are executed at prices which are also very good value for the tax payers.

In multi-family, as you know, the large majority of the credit risk is laid off through securitization, which made a $200 billion milestone in the second quarter. We have relatively little residual credit risk on our books for new flow multi-family mortgages.

Given these strong fundamentals, we have a dividend requirement of $2 billion in September. To-date, we returned more than $108 billion to taxpayers, about $37 billion more than we have received.

Put another way, we returned over 150% of what we have received. Now let’s turn to the bigger picture: how has Freddie Mac evolved a conservatorship.

Those of you who have spoken with me in the past, you know that I was no fan of the old and flaw GSE model, despite the good value of the core securitization activity being done. I saw it from the other side as a customer and the market counter priority, and I didn’t like it with those flaws.

The timeout that this conservatorship has enabled management with the oversight and support of the FHFA to transform the company into what is now a well-run competitive financial institution, the best of the old GSE system without its evidence flaws. This is most seen in the game changers we have implemented along the way.

Credit-risk transfer is the biggest of them all, the best innovation in this market in at least a generation. We now expose our credit underwriting to the marketplace for validation, and of course, reducing tax payers’ exposure to such concentrated mortgage risk is a very big and positive deal.

Shrinking retained portfolios is another game-changer. We went from over $850 billion at its peak, and we are now approaching mandated $250 billion target.

And we did so in a tax payer-efficient manner. In fact, the FHFA has us aiming to come in 10% lower than the target.

We also leveled the playing field and pricing for small lenders, no more pricing breaks for the biggest banks. On the multi-family side, we developed a new business model, the superior underwriting and very strong credit-risk transfer that has changed our role in the market substantially.

Beyond all these financial comments are about our balance sheet, we have also become a much more customer-centric company, which was relatively far into the GSEs of all. We are investing heavily in customer technology in single-family and have improved our response times to customer increase all around as but a few examples.

Our transformation is helping us to better serve our mission, because it’s not enough for us just to be a well-run competitive financial institution. The GSEs have a mission that is entirely unique in the FI world.

The GSEs are specifically charged with creating liquidity, stability and affordability in this secondary market and no one else has our comprehensive set of affordable housing obligation. So we are creating a better company to better serve that unique mission.

Here are just a few examples of how we are better delivering on that mission. Our Home Possible affordable lending products in single-family are in track to reach about 70,000 borrowers this year in 2017, doubling our purchase volume from last year.

Importantly, about 8 out of 10 of these loans are helping first-time home buyers. On the multi-family side, our small-balance loan program is performing exceedingly well.

Just a few years old is funding for these smaller rental properties increase more than 40% from last year. These properties are significantly more likely to be affordable to working families versus the average flow we have.

And now we are embarking on our Duty-to-Serve efforts working with the FHFA to develop the ability to responsively expand home ownership to markets with extreme needs: specifically one, rural areas; two, manufacturer housing; and three, affordable housing preservation. We're reviewing the feedback received during the recent comment period and using it to fine tune our extensive Duty-to-Serve plan.

At the same time, we are already actively working on many Duty-to-Serve programs. As one example, we're already engaged with our Energy Task efficient task force and our Manufactured Housing task force, both made of industry experts to implement our plans.

Add it all up, the company as a whole provided nearly $100 billion of funding to the primary mortgage market just in the second quarter alone, a big number that made home possible for a big number of families. That's proof we're delivering on our mission.

With that, let me wrap up by saying this is not your parent's Freddie Mac, and anybody who thinks it is hasn't been watching the last five years. The business fundamentals are strong and residual flaws are nearly gone.

Our commitment to community mission and our customers is stronger than ever. We are clearly a better Freddie Mac, and we're building a better housing finance system.

I'll now open it up to your questions.

Hi, good morning. I was wondering if you could walk through the changing language in the press release around the dividend concern: I guess why you guys decided to change it now, whether you received any indication that you might not make the planned dividend payment, and also to kind of walk through what happens in terms of the liquidation preference and all that if for whatever reason the full payment is not made this time.

Okay. You've asked two questions.

The first one, the language is just being tightened up to be more technically accurate with the legal obligation. There is no implication about any change in that.

If we were direct - we are directed to pay dividend or not by the FHFA, it is not in our discretion. If we were directed not to do so, under the existing terms of the existing PSPA, the amount not paid would be added to the liquidation preference, so we will just technically owe it at a later date.

Got it. So you're saying you're tightening up the leverage a bit, but I guess what you said would have been true any quarter, right?

And the PSPA haven't changed since 2012. So I guess what's driving the change now?

Yes, the technicality is, we're saying what our dividend will be; however, we don’t get directed to pay the dividends well past the date of the 10-Q or 10-K being issued. So we actually don't know we're supposed to pay it or not until we see that direction from the FHFA.

And we looked at that language last quarter. I think we tweaked a little bit then and we're constantly looking at the press release and updating things and speaking them.

Okay. That was Jim Mackey, our CFO, by the way.

Got it. And I guess we’ll try this one last time, but what you just went through that was through any question, right?

So are you saying that Watt’s testimony in May, for example, had nothing to do with it?

Correct.

Okay, thank you.

Hi. I wondered if I could ask two questions.

One was on the Home Possible volume. It sounded like you give the number of borrowers -- or gave us a number of borrowers 70,000 this year is about -- compared to last year it’s about double.

How does that -- I don’t know if you could give me a sense of what percentage of volume the Home Possible loans make up?

I am trying to do some numbers in my head. Give me a second here.

Do you know how many purchase volume during the year is likely?

Okay. And the other thing I wanted to clarify was the change in the hedge accounting.

It sounds like it was just a change in the accounting not in the actual hedging strategy. Do I understand that right?

You understand that totally correct. We have been hedging for economics, and we state for interest state risk, we hedge to get to a very low level as based on our models.

That is both our policy and the preference of the FHFA and Treasury, who consider it in appropriate to bake that kind of discretionary risk while our conservatorship with tax payers’ support, but we aim for the zero. The problem is the accounting, and we came up in accounting solution to an accounting issue.

The underlying economic hedging has not changed.

So that was Jim. So now our accounting more aligns with the economics it follows.

It’s not perfectly match, but it’s well closer.

Okay, thank you.

Okay. For everyone, thank you for joining us this morning.

I hope you enjoy the rest of your summer, and I look forward to talk to you next quarter, where hopefully our results would be as good as this quarter. Thank you and good morning.