Freddie Mac's latest sale of risk-sharing bonds, its biggest yet, was structured in a way that will help reduce the earnings volatility that's added to concerns that the mortgage giant may again need to tap taxpayer funds.
That's because the initial version of the notes — through which it’s shifting risk to investors on more than 10% of its $1.6 trillion in mortgage guarantees — needed to be accounted for as derivatives and subject to regular valuations that affected profits, according to Mike Reynolds, a vice president of credit-risk transfer at Freddie Mac.
The original treatment "can create income-statement volatility," Reynolds said in a telephone interview. The new bonds aren't considered derivatives, so they "do not have that volatility. We see that as a more sustainable vehicle to be able to grow the numbers in a large way."
Freddie Mac and competitor Fannie Mae, which were seized by the U.S. in 2008, still operate much like normal companies in reporting earnings, which are used to determine how much they owe or will take from the Treasury. Freddie Mac posted $3.4 billion in derivatives losses in the fourth quarter largely tied to a drop in interest rates, which because of accounting rules weren't offset by changes in the values of assets being hedged.
After the period in which Freddie Mac's profits fell to $227 million from $8.6 billion, a watchdog for its overseer said last month that Freddie Mac and Fannie Mae's ability to keep posting profits shouldn’t be presumed. Shareholders argue that the companies should be allowed to retain earnings now being passed on to the U.S. to address the risk of quarterly losses requiring more draws from their Treasury bailout lines.Freddie Mac, which has paid $21 billion more than the $71 billion it took during the housing slump, and Fannie Mae began turning to the risk-sharing deals in 2013 to reduce taxpayer dangers. At the same time, buying the protection can lower Freddie Mac's income because it makes regular payments on the debt, Reynolds said.
With its latest deal Wednesday, the structure was changed so that investors can see their principal erased by amounts generally equivalent to losses suffered on its guarantees. Previously, losses were based on fixed percentages for each default.
While some investors complained about an adjustment that left buyers at risk from loan modifications, the deal’s size was increased to $1 billion from $720 million and more than 100 firms put in orders before the yields at which the debt was being marketed were lowered, according to Reynolds.
Freddie Mac sold the securities that are first in line to suffer losses at yields that float 9.2 percentage points above a benchmark rate, the company said. That compares with a potential spread as high as 10.25 percentage points in earlier marketing and the yield premium of 10.75 percentage points on a similar slice of its previous deal last month.
Regarding loan modifications, Reynolds said many investors see Freddie Mac's oversight of outstanding loans as "better than all the alternatives" and that it has incentives to properly manage policies on homeowner aid because it also shares the risks.
"We always have skin in the game," he said. "We always have money on the line."