Federal Home Loan Mortgage Corporation

Jeffrey Markowitz – Senior Vice President of External Relations Don Layton – Chief Executive Officer Jim MacKey – Chief Financial Officer

Joe Light – Bloomberg Lorraine Woellert – Politico

Thank you. Good morning, everyone, and thank you for joining us for a discussion of Freddie Mac’s third quarter 2017 financial results.

We’re joined today by the company’s CEO, Don Layton; CFO, Jim MacKey; and General Counsel, Bill McDavid. Before we begin, we’d like to point out that, 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 also may discuss the 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. The 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 will now turn the call over to Don Layton, Chief Executive Officer of Freddie Mac.

Good morning, and thanks for joining us on our quarterly earnings press call. In conservatorship it is one of the few opportunities to publicly address our business and operating performance here at Freddie Mac.

And so I look forward to it and hope you do as well. First, I will address overall corporate financial and operating results, they were excellent on several levels.

Second, I will get into the individual lines of business. Behind the specifics of each, you will hear the recurring theme of business transformation, a big part of which is going from the not-very-competitive past to the very-competitive present, where we compete as if there were 3 or 5 or 8 GSEs not just 2.

And how this is better for America’s lenders, taxpayers, homeowners and renters in reformed housing finance system. Our shorthand for this is, transform and reform.

So first up, financial and operating results. Earnings were unusually high at $4.7 billion as measured by both comprehensive income and net income.

I remind you that comprehensive income is the more important for us, while we are in conservatorship. As previously disclosed, there was a PLS security settlement in the third quarter, which generated a $2.9 after-tax gain.

Given how the PSPA our U.S. Treasury support agreement is currently structured, the beneficiary of this gain will be U.S.

taxpayers. I will now focus on our comprehensive income absent this gain, which came into strong at $1.8 billion after tax, that is the important number for everyone to focus on during this talk.

There were additionally two noteworthy but roughly offsetting items within the $1.8 billion. First, we took an additional provision for loan loss reserves of $600 million after tax with the three hurricanes Harvey, Irma and Maria.

About 2/3 of this additional reserves are related to Maria, because at this time we expect a considerably higher severity of losses in Puerto Rico and the Virgin Islands that on the Mainland. Second, we also had a $600 million after tax increase in profits from various market related items.

A little more than half of this was from tightening market spreads and about 1/3 was related to the disposition of less liquid assets from the mortgage-related investments portfolio. In terms of the fundamentals and underlying business, we are very happy with our performance.

It shows the transformation of our business model along with improving execution. First, as the growth of the businesses.

The guarantee books grew by 5% year-over-year to nearly $2 trillion. This growth reflects a healthy market for housing and mortgages in America as well as our strong participation in it.

Second, the mortgage-related investment portfolio balance was reduced by 30% from a year ago. This reflects not just the requirement placed by – placed on us by the U.S.

Treasury and the FHFA. It also reflects the economically efficient disposition of liquid mortgage – illiquid mortgage assets, which are also in this case, generally impaired.

The gains mentioned previously are one reflection of the effectiveness with which we are disposing of such assets. Third, our business model is more and more about passing through the credit risk on our guarantees to private capital sources through our various CRT that is credit risk transfer transactions.

In fact, we just passed the major milestone of completing a transfer of significant credit risk in more than $1 trillion of mortgages. And fourth, credit quality remains very good.

I will give specifics by each of the business lines shortly. Our strong results mean we are scheduling to pay our dividend of $4.7 billion to treasury in December.

Our total payments to the treasury through September are about $110 billion, approximately 55% more than we received and this is prior to the latest schedule payment. Now let me turn to some quick highlights for each of the businesses starting with single family our largest.

We continue to grow this business profitably. The single-family guarantee portfolio grew 4% from the prior year reaching $1.8 trillion in the third quarter.

The serious delinquency rate at 86 basis points continues to be near the lowest point since early 2008. However, it did pick up 1 basis point this quarter.

We expect it to increase for at least several quarters due to the 3 hurricanes. The serious delinquency rate for the post 2018 book, excluding refinancing like HARP, is however, just 19 basis points.

A reflection of a strong housing market with prices rising at a good clip. Long run, we expect delinquency measures to the entire single-family guarantee portfolio to improve as the legacy pre 2009 book declines to run off in disposition transactions.

We’ve also invested heavily in new technology and new capabilities to help our customers, America’s lenders, to operate more cost effectively and to better serve their borrowers. Our most recent development on this front is the addition of automated collateral evaluation or ACEs through our Loan Adviser Suite technology.

ACE allows lenders to weigh the traditional appraisal on qualifying properties, which can save borrowers, we estimate roughly $500 on average a closing as well as speeding up the closing process by as much as 7 to 10 days. On more personal note, I just returned from the big annual MBA meeting held this year in Denver.

Our emphasis on improving customer focus and service in contrast to the traditional reputation of the GSEs prior to conservatorship was on full display. I was just checking in on the first day and the lender’s CEO approached me, introduced himself and began to tell me how appreciative he was about our improved customer focus, how it was so much better than the traditional GSE levels.

And this kind of thing happened a few times every day I was there. Naturally it was great to hear this directly from the proverbial horse’s mouth.

Now let me turn to multifamily. It continues to be an excellent year with strong demand in the multifamily market.

And Freddie Mac is leading the charge in the industry to meet this demand in a transformed manner. We had record purchase volume of $19 billion in the third quarter.

Year-to-date volume is up 17%. Outstanding loan purchases are also up significantly – excuse me, outstanding loan purchase commitments are also up significantly.

Importantly, about 83% of the nearly 200,000 rentals we financed in the third quarter were to families earning at or below area median incomes. This reflects our emphasis on workforce housing, which is as it should be for GSE.

The multifamily guarantee book is up by 23% from last year. Reflecting strong market growth and our successful participation in it.

Delinquency rate to the multifamily book of business, even the four considerations of credit risk transfer continue to remain near zero. And I wish to remind everyone, we are reforming the marketplace in multifamily lending by amongst other things placing private market capital at the forefront of the business model, the famous K-Deal execution along with newer variations.

Today, right now we distribute the vast majority of credit risk on almost 90% of our new business flow. This is definitely not the same old GSE business model from yesteryear.

Now let me finish with a few highlights in the capital markets business. Our goals here are to support the guarantee businesses, while efficiently reducing the legacy assets, which were generated by the financial crisis from nearly a decade ago, for having success on both fronts.

An example of supporting the guarantee business is would be how we have invested in and grown our single-family cash window capabilities. Where small and medium-sized lenders can access the capital markets in an efficient manner.

While less than 15% of our flow in 2011 was via the cash window, it is now running closer to 40% of new flow. That’s a big improvement in supporting lenders of all sizes.

Additionally, our mortgage investment portfolio at $267 billion, is fast approaching the mandated $250 billion target maximum. We will aim to be below this level to provide a cushion as required by the FHFA in just over a year from now.

This reduction has been done with a very strong focus on transactions, they are done in prices, favorable to the taxpayers who support us. A major example of this would be the reduction in our single-family PLS portfolio, which peaked at $186 billion in 2005, it is now down with a 95% with just $7 billion left.

And every disposition transaction was done in prices we view as taxpayer friendly. There was no dumping of assets in this disposition program.

With that let me wrap up. What I want you to walk away with today is that we’re a transformed company that is helping to reform the mortgage industry to make it serve borrowers, renters and taxpayers as well as our lending customers better all the time.

And that this in turn is also driving strong business results. Everyday our employees come to work to serve our mission and make home possible for millions of families all the while making Freddie Mac a better company.

And they are also working to make the housing finance system better as well. The management team and I are very proud of their hard work and dedication.

I will now open it up to your questions.

Hi thanks for taking my question. I was wondering if you could talk a bit more about the projected losses from the recent hurricanes.

I think after Katrina, both of you guys and Fannie took a huge provision for credit losses, which ended up getting adjusted pretty sharply down over time. So I was wondering, if you could talk about how firm the $600 million figure is, and are the knowns and unknowns in terms of potential damages and credit losses that might result?

Thank you, Joe. I actually – before getting to your question.

I did one flub as I went through the script, I talked about our delinquency – sorry, delinquency rate, single family at 86 basis points, I said this was the lowest points since July 2018. It was early 2008, I was in the present not a decade ago.

In terms of your questions, okay, so we took $270 million after tax at $900 million pretax approximately. And we have 3 hurricanes.

But they really break down into the Texas and Florida hurricanes. Those we have a remapped information with which to go through a multiple ways of trying to estimate what the loan loss provision should be at this time.

They also were informed heavily by what you noted the experience in both Katrina and technically it was not a hurricane, super storm Sandy where there was large charges given what was assumed to be lots of uninsured losses and then as everything from people’s owned resources to government spending in such, it ends up being much less. So over time – so we’ve learned from that, we used those as good information.

So the reserves there are relatively modest out of that $900 million pretax. The Maria in Puerto Rico and the Virgin Islands presents a much different situation.

We have much less information. The information we do have shows a much worse saturation in terms of what kind of destruction it was, the ability to recover the underlying ability of services to do their job and on and on and everyone is familiar with the general background of Puerto Rico having its – in particular, having its own troubles as a government in quasi bankruptcy and such.

In addition, just being islands not able to have lots of things be driven to them is making things worse. So in that, we went through a structured process that is designed to fit gap.

We came up with what we consider reasonable best estimates. It clearly has a decent standard deviation for, those are my words not gap words, decent standard deviation of estimate for the 2 mainland hurricanes and a large one for Puerto Rico.

We will adjust if necessary as new information comes in.

And I want to – just not get too much in the weeds.

What happens, when you have events like this, so your models can’t so your models can’t capture the actual results. So you look at your history and make your best estimate based on the facts that you have.

And so what happens over time is your models then begin to catch up and it gets incorporated into your regular reserving process on a quarterly basis. So over time, the farther away way you get from the event it’s hard to tell whether a loss is from the event or just something else.

So it gets muddled. So I wouldn’t say that on prior hurricanes there were reserves booked and they were released, it just became part of the normal process over time.

Have we confused you enough, Joe?

No, no thanks.

Hey guys, could you elaborate just a little more on the actual numbers that you set-aside, the dollars that you set-aside. You said Texas in Florida is one thing and then Puerto Rico is another.

Can you break down the pretax and after-tax amounts for each?

Well, no. I believe the only disclosure we’re making is that Maria was about 2/3 of the total.

It’s $900 million pretax, it’s $600 million after tax and about 2/3 is Maria.

Okay. Got it thank you.

As I said in my prepared text. The severity assumption on Puerto Rico and Virgin Islands is considerably higher for all the reasons we said.

Okay. Thank you for joining us this morning.

I hope you enjoy the upcoming holiday season. And I look forward to talking to you next quarter when we have full year results.

Thank you.