Federal Home Loan Mortgage Corporation

Thank you. Good morning, everyone and thank you for joining us for a discussion of Freddie Mac's full year and fourth quarter 2018 financial results.

We're joined today by the Company's CEO, Don Layton; President, David Brickman; CFO, Jim MacKey; Chief Administrative Officer, Jerry Weiss; and General Counsel, Ricardo Anzaldua. Before we begin, I'd like to point out that during the 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 annual report on 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 release and related materials, which are posted on the Investor Relations section at freddiemac.com.

Our commentary today will be limited to business and market topics. As you know, we cannot comment on public policy or legislation concerning Freddie Mac.

As a reminder, this call is for the media and only they can ask questions. This call is being recorded, and a replay will soon be made available on freddiemac.com.

We ask that this call not be rebroadcasted or transcribed. With that, I will now turn the call over to Don Layton, Freddie Mac's CEO.

Good morning and thank you for joining us to discuss our fourth quarter and full year 2018 financial and business results. We appreciate the opportunity to review our performance with you and look forward to your questions.

2018 was another excellent year for Freddie Mac. 10 years after the financial crises, our transformed business model continues to produce solid earnings.

The transformed model also helps us to fill our mission of promoting liquidity, stability and affordability to the US mortgage market and we now do so in an economically efficient manner that properly values the taxpayer support of the company. I'd like to accomplish two things with this morning's discussion.

First, I will cover our financial and business results for last year. Second, I'll describe how fundamental changes in our business model have strengthened Freddie Mac and the overall housing finance system.

In 2018, we saw increased comprehensive income, a higher return on conservatorship capital, continuing growth in the guarantee book and strong momentum in our efforts to ship credit risk away from the taxpayer and towards the private sector. Let's start with the bottom line numbers.

For the full year, we earned comprehensive income of $8.6 billion. Adjusting for significant items, our 2018 comprehensive income was $8.4 billion, an increase of 4% over 2017.

Market sensitive items resulted in just a $0.5 million reduction in earnings for the year, almost all through the interest rate movements. Of note quarterly volatility of income in 2018 was significantly reduced by having hedge accounting in place as well.

Looking at the balance sheet we saw good growth in our guarantee book at 5%, which means we are participating fully in overall mortgage market growth. As of December 31, total guaranteed assets stood at $2.1 trillion, compared with $2 trillion the year before.

Our credit quality still looks very good with yearend delinquency in the multifamily book at virtually zero, just one basis point like single family seriously delinquent -- like single families likewise, single-family serious delinquencies were at the lowest level in more than a decade at 0.69%. Looking at just our core single-family portfolio, which excludes relief refinance mortgages and mortgages acquired prior to 2019 our serious delinquency rate is even lower at 0.22%.

This reflects strong underwriting and also strong house price appreciation and these numbers please note, do not give us back to CRT transferring to private market unexpected and more recently expected losses that result from these delinquencies. In each of the past two quarters, I've updated you on a relatively new measure of how well we manage our business.

ROCC or returning conservatorship capital, which functions as a proxy during conservatorship for the return equity calculation, commonly used by financial institutions. For the entire year, we reported approximately 15% return.

While this is good, I should again caution that all else being equal and actual ROE outside conservatorship will likely be below this level. I won't go into the reasons for that now, but we'll be happy to address it during Q&A.

Nevertheless, our ROCC remains the only official metric to gauge whether we are earning a good return on behalf of the taxpayers' exposure to our risks. The strong return in 2018 demonstrates both our commitment to making business decisions that are in the best interest of taxpayers and our belief that the company does capital management as well as some of the best managed large FIs in the country.

Along with the effect of continued solid underlying earnings, a key factor in achieving our strong return, was the efficient use of capital, including by reducing the risk that requires it. 2018 -- at year-end 2018, model capital, as defined by the conservatorship capital framework had declined $11 billion or 16% compared with year-end 2017.

A variety of factors play a role in that decrease, including ongoing appreciation home prices, our innovative legacy asset dispositions and our leadership and credit risk transfer across both the single-family and multifamily business segments. I believe that a 16% reduction, which represents significantly less risk to the taxpayer along with increased profit is very good performance.

Probably through the extensive implementation CRT, our single-family business reduced its conservatorship capital need for credit risks on loans purchased during 2017 by approximately 60%, while our multifamily business achieved approximately a 90% reduction in that risk. Not that we calculate those numbers based upon loan purchases from the prior year, reflecting that CRT has almost always after a loan is purchased during a securitization pipeline period, which we standardize as 12 months for this calculation.

Those are obviously very good results for taxpayers and for the housing finances. I'd also like to point out that we generated good level of earnings, $1.5 billion in the fourth quarter, a period characterized by highly unsettled markets.

Demonstrating our transformed business model strength, our ROCC for that period was still above 10% even in the face of that volatility. All in then, 2018 was a good year for us.

The strength we demonstrated in the fourth quarter, our ability to deliver a profit while supporting our mission under market pressure did not happen by accident. In fact, since the financial crisis, Freddie Mac has worked with its conservator to address the major challenges in the historic GSE business model.

The fundamental changes we implemented have benefited everyone involved in housing finance; taxpayers, borrowers, renters, investors, sellers servicers and Freddie Mac too. For example first our retained portfolio is a fraction of its former size.

We address a large structural weakness in the former housing finance system that's the unlimited size of the subsidized discretionary investment portfolios that have historically generated profit, largely independent of the guarantee business. Where Freddie Mac's retained investment portfolio once balloons more than $800 billion at the end of last December, it was just $218 billion, nearly a 75% reduction and well below the $250 billion limit required by the purchase agreement with the treasury.

Today we use a retained portfolio to support the guarantee business for example, by purchasing defaulted loans and securitization to facilitate modification for homeowners and to make good on our guarantee to investors. Second, we have a capital framework that encourages risk versus reward discipline.

We developed a modernized GSE risk-based capital system over five years ago. It is patterned after the one applied to the banking system script [ph] which are required to show that they can weather a fed-specified severely adverse stress scenario, while retaining s going concern buffer.

We've adopted that framework even before became the basis for the conservatorship capital framework mandated by FHFA, which it strongly resembles. Today the CCF framework gives us and the taxpayers who support us, confidence that we are making taxpayer friendly risk reward decisions each and every day.

It also helps us give taxpayers a decent return on their exposure to our risk. Third, we've leveled the playing field for Community Banks and other small lenders at one time, more than 80% of Freddie Mac's guarantee business came from its top 10 customers who enjoy discounted guarantee or GPs as they're known because of their large size.

Working with FHFA, we have ended that practice and today lenders of all size pay level GPs. We also maintain a very competitive cash window, which enable small lenders to access the global capital markets, even when selling us just one or two loans at a time and we dedicated more technology, customer support and other resources to smaller lenders since entering conservatorship.

As a result, approximately half of our single-family business now comes from outsider top 10 customers versus less than 20% prior conservatorship. Finally, and as previously mentioned, we have significantly reduced our exposure to systemically large amounts of mortgage credit risk.

We do this primarily through the programs that transfer risk from new loan purchases to private investors and the way from the US taxpayer. In 2018, these included our [indiscernible] programs in a single-family, together with pioneering risk transfer programs in multifamily.

We've also substantially reduced the concentration of credit risk found in our retained portfolio, less liquid assets, which are primarily credit impaired. It is now just 30% of the much reduced total of that portfolio.

More broadly to give you an idea of how far we've come in risk reduction, once a year FHFA publishes our stress test results, which estimate how much funding we would need to draw from treasury under the fed severely adverse scenario. Back when we reported 2013 stress test results, that's the first time we did, that number was $93 billion and even with a tougher scenario this past year, it declined by almost two thirds to $35 billion.

That was deducted. In addition to the structural reforms like all financial services companies, we're in the midst of a digital transformation.

One example is our focus on speed of execution with our customers. In single-family, we are automating the income and asset verification process, which has traditionally been paper-based and slow.

So costs are coming down and speed is increasing. In multifamily, we are now arranging digital communications with property inspectors via an app.

So days are squeezed out of the process. It's these types of efforts that are helping bring the traditional time and paper intensive mortgage business into the digital age.

The payoff for these efforts shows up at our customer satisfaction scores, which are on par with top performing financial services companies. One thing that has not changed however is our mission.

Last year Freddie Mac provided $396 billion in liquidity to the US mortgage market. Looking behind that number we help lenders find more than 1.3 million single-family homes, with first-time homebuyers taking nearly -- out nearly 46% of new purchase loans.

We also help fund nearly 866,000 multifamily rental units with more than 90% affordable for low and moderate income families earning at or below 120% of the area median income. Altogether that means than in 2018 Freddie Mac made a difference in the lives of over two million families and that's what inspires our people every day.

So I'll stop there with just one final thought. I am proud of the improved GSE business model and our transformation into a competitive, innovative company.

It serves our customers and fulfils our congressionally mandated mission, all much more efficiently than in the past and now sees taxpayers properly for their support of the company. I'm proud that this happens on my watch which is scheduled to conclude later this year and that we at Freddie Mac lived so much of it.

In fact, GSE's and FHFA now regularly get compliments in the housing finance policy community about how much the business model has improved during conservatorship. My colleagues of Freddie Mac and FHFA past and present should be feeling very good about it.

With that I will be happy to take your questions.

What about front end credit risk transfers? You spoke about the more traditional CRT deals you've done.

How are those -- how is that coming along for Freddie Mac? What sort of goals does Freddie Mac have with that?

Okay. I'll leave a few cuts in answering that.

First of all the FHFA has tried in their disclosures, which they do every six months on how CRT is going for both GSEs. They have recently said if you look back, which is true, traditional MI is just a type of front end credit risk transfer.

So they have included that in the definition. So in terms of that environment -- that product, you know it's been there, it's been a large amount, they’ve been looking to improve it with their various P.

Myers releases, the second one got done last year and the third one I believe is in the works. In terms of leaving our traditional MI, what kind of front end credit risk transfer?

Our credit risk transfer, we always try to have? We're open to any type that is properly cost that is the applied cost of capital is not too high and that has proper counterparty mechanism in it.

In that competition between different types, front end credit risk transfer is not in the range only but in the range of credit risk transfer has developed a small market share because quite honestly it's scale is usually much smaller than our big back end transfer and things. And so it has a niche and we've had some of few nice transactions with certain lenders.

So it's growing a bit but it's currently clearly a secondary source of CRT so far and we don't expect that to change.

Okay. Thank you for your time and attention this morning.

Just to quickly summarize, our earnings year of earnings, high-quality earnings, stable earnings is our pattern and we're particularly proud of that. We are much less risk intensive than the past, which means the taxpayers are supporting us less and less, which is a good thing.

And on that note, have a nice day. Thank you for listening.