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| FRE > SEC Filings for FRE > Form 10-Q on 6-Nov-2009 | All Recent SEC Filings |
6-Nov-2009
Quarterly Report
You should read this MD&A in conjunction with our consolidated financial statements and related notes for the three and nine months ended September 30, 2009 and our 2008 Annual Report.
Overview
Freddie Mac was chartered by Congress in 1970 with a public mission to stabilize the nation's residential mortgage market and expand opportunities for home ownership and affordable rental housing. Our statutory mission is to provide liquidity, stability and affordability to the U.S. housing market. Our participation in the secondary mortgage market includes providing our credit guarantee for residential mortgages originated by mortgage lenders and investing in mortgage loans and mortgage-related securities. Through our credit guarantee activities, we securitize mortgage loans by issuing PCs to third-party investors. We also resecuritize mortgage-related securities that are issued by us or Ginnie Mae as well as private, or non-agency, entities by issuing Structured Securities to third-party investors. We also guarantee multifamily mortgage loans that support housing revenue bonds issued by third parties and we guarantee other mortgage loans held by third parties. Securitized mortgage-related assets that back PCs and Structured Securities that are held by third parties are not reflected as assets on our balance sheets. We earn management and guarantee fees for providing our guarantee and performing management activities (such as ongoing trustee services, administration of pass-through amounts, paying agent services, tax reporting and other required services) with respect to issued PCs and Structured Securities.
We are focused on meeting the urgent liquidity needs of the U.S. residential mortgage market, lowering costs for borrowers and supporting the recovery of the housing market and U.S. economy. By continuing to provide access to funding for mortgage originators and, indirectly, for mortgage borrowers and through our role in the Obama Administration's initiatives, including the MHA Program, we are working to meet the needs of the mortgage market by making homeownership and rental housing more affordable, reducing the number of foreclosures and helping families keep their homes.
We had net loss attributable to Freddie Mac of $5.0 billion for the third quarter of 2009 and total equity of $10.4 billion as of September 30, 2009. Net loss attributable to common stockholders was $6.3 billion for the third quarter of 2009, which includes the payment of $1.3 billion of dividends in cash on the senior preferred stock. Our financial results for the third quarter of 2009, compared to the second quarter of 2009, reflect the unfavorable impact of decreased interest rates on the fair value of our derivatives and our guarantee asset, as well as increased credit-related expenses. These unfavorable impacts were partially offset by gains on trading securities due to tightening OAS and lower interest rates, gains on sales of available-for-sale securities and reduced net impairments on available-for-sale securities recognized in earnings. Total equity increased $2.2 billion during the quarter from $8.2 billion as of June 30, 2009. The increase included $8.3 billion of fair value improvement on available-for-sale securities within AOCI, due primarily to declines in interest rates and tightening of mortgage-to-debt OAS, offset by the third quarter 2009 net loss attributable to Freddie Mac of $5.0 billion and senior preferred stock dividends of $1.3 billion.
We expect a variety of factors will continue to place downward pressure on our financial results in future periods, and could cause us to incur further GAAP net losses and request additional draws from Treasury under the Purchase Agreement. Key factors include the potential for continued deterioration in the housing market and rising unemployment, which could result in additional credit-related expenses and security impairments, adverse changes in interest rates and spreads, which could result in mark-to-market losses, additional impairment of our investments in LIHTC partnerships, and our efforts under the MHA Program and other government initiatives, some of which are expected to have an adverse impact on our financial results. While the housing market has experienced recent modest home price improvements beginning in the second quarter of 2009, we expect home price declines in future periods. Consequently, our provisions for credit losses will likely remain high during the remainder of 2009. Further, our senior preferred stock dividend obligation, combined with potentially substantial quarterly commitment fees payable to Treasury beginning in 2010 (the amounts of which have not yet been determined), and our inability to pay down draws under the Purchase Agreement will have a significant adverse impact on our future net worth. To the extent that these factors result in a negative net worth, we would be required to take additional draws from Treasury under the Purchase Agreement. For a discussion of factors that could result in additional draws, see "LIQUIDITY AND CAPITAL RESOURCES - Capital Adequacy".
Recent Management Changes
Several significant management changes occurred recently:
• On August 10, 2009, Charles E. Haldeman, Jr. began serving as our Chief Executive Officer and as a member of our Board of Directors. Mr. Haldeman succeeded John A. Koskinen, who served as our Interim Chief Executive Officer and performed the functions of principal financial officer and who returned to the position of Non-Executive Chairman of the Board;
• On September 14, 2009, Bruce M. Witherell began serving as our Chief Operating Officer; and
• On October 12, 2009, Ross J. Kari began serving as our Chief Financial Officer.
Business Objectives
We continue to operate under the direction of FHFA as our Conservator. During the conservatorship, the Conservator delegated certain authority to the Board of Directors to oversee, and to management to conduct, day-to-day operations so that the company can continue to operate in the ordinary course of business.
We changed certain business practices and other non-financial objectives to provide support for the mortgage market in a manner that serves public policy, but that may not contribute to profitability. Some of these changes increase our expenses, while others require us to forego revenue opportunities in the near term. In addition, the objectives set forth for us under our charter and by our Conservator, as well as the restrictions on our business under the Purchase Agreement with Treasury, may adversely impact our financial results, including our segment results.
There is significant uncertainty as to whether or when we will emerge from conservatorship, as it has no specified termination date, and as to what changes may occur to our business structure during or following our conservatorship, including whether we will continue to exist. However, we are not aware of any current plans of our Conservator to significantly change our business structure in the near-term. As discussed below in "Legislative and Regulatory Matters - Federal Legislation and Related Matters," Treasury and HUD, in consultation with other government agencies, are expected to develop legislative recommendations for the future of the GSEs.
MHA Program and Other Efforts to Assist the Housing Market
We are working with our Conservator to help distressed homeowners through initiatives that support the MHA Program. We also implemented a number of other initiatives to assist the U.S. residential mortgage market and help families keep their homes, some of which were undertaken at the direction of FHFA. If our efforts under the MHA Program and other initiatives to support the U.S. residential mortgage market do not achieve their desired results, or are otherwise perceived to have failed to achieve their objectives, we may experience damage to our reputation, which may impact the extent of future government support for our business.
During the third quarter of 2009, we continued to enhance our infrastructure and capacity to support the MHA Program by devoting significant internal resources to support the increased activity under both of its key initiatives: the Home Affordable Refinance Program and the Home Affordable Modification Program.
Home Affordable Refinance Program
The Home Affordable Refinance Program gives eligible homeowners with loans owned or guaranteed by Freddie Mac or Fannie Mae an opportunity to refinance into loans with more affordable monthly payments. The Freddie Mac Relief Refinance Mortgagesm is our implementation of the Home Affordable Refinance Program for our loans. As of
September 30, 2009, we purchased approximately 98,000 loans totaling approximately $20.0 billion in unpaid principal balance under this program, including approximately 54,000 loans with current LTVs above 80%.
We expect to continue to experience strong demand for the Freddie Mac Relief Refinance Mortgage due to low interest rates and recent enhancements to the program. These enhancements were designed to help more borrowers take advantage of the program, and include:
• increasing the maximum allowable current LTV ratio of a Freddie Mac Relief Refinance Mortgage to 125%;
• allowing borrowers to refinance a Freddie Mac-owned or guaranteed mortgage with any lender affiliated with Freddie Mac; and
• increasing the amount of closing costs that can be included in the new refinance mortgage up to $5,000.
Home Affordable Modification Program, or HAMP
HAMP commits U.S. government, Freddie Mac and Fannie Mae funds to help eligible homeowners avoid foreclosure and keep their homes through mortgage modifications. We have focused our loan modification efforts on HAMP since it was introduced in the second quarter of 2009, and have completed 471 modifications under HAMP as of September 30, 2009. Under HAMP, borrowers must complete a trial period of three or more months before the loan is modified. Our overall loan modification volume declined in the third quarter of 2009 as compared to the second quarter of 2009 because borrowers did not begin entering into trial periods under HAMP in significant numbers until early in the third quarter and, in many cases, trial periods were extended beyond the initial three month period as HAMP guidelines were modified. Based on information reported by our servicers to the MHA program administrator, more than 88,000 loans that we own or guarantee were in the trial period portion of the HAMP process as of September 30, 2009. Trial period loans under HAMP are those where the borrower has made the first payment under the terms of a trial period offer.
Through September 30, 2009, our loss mitigation activity under HAMP has been primarily focused with our larger seller/servicers, which service the majority of our loans, and variations in their approaches may cause fluctuations in HAMP processing volumes. There is uncertainty regarding the sustainability of our current volume levels once our larger seller/servicers complete the bulk of their initial efforts. The completion rate for HAMP loans, which is the percentage of loans that successfully exit the trial period due to the borrower fulfilling the requirements for the modification, remains uncertain due to the number of new requirements of this program. We have undertaken several initiatives designed to increase the number of loans modified under HAMP, including:
• engaging a vendor to help ease backlogs at several servicers by processing requests for HAMP modifications;
• engaging a vendor to meet with eligible borrowers at their homes and help them complete loan modification requests; and
• implementing a second-look program designed to ensure that borrowers are being properly considered for HAMP modifications. Borrowers who do not qualify for HAMP are then considered under the company's other foreclosure prevention programs.
We also serve as compliance agent for certain foreclosure prevention activities under HAMP. Among other duties, as the program compliance agent, we will conduct examinations and review servicer compliance with the published requirements for the program. We will report the results of our examination findings to Treasury. Based on the examinations, we may also provide Treasury with advice, guidance and lessons learned to improve operation of the program.
The MHA Program is intended to provide borrowers the opportunity to obtain more affordable monthly payments and to reduce the number of delinquent mortgages that proceed to foreclosure and, ultimately, mitigate our total credit losses by reducing or eliminating a portion of the costs related to foreclosed properties and avoiding the credit loss in REO. At present, it is difficult for us to predict the full impact of the MHA Program on us. However, to the extent our borrowers participate in HAMP in large numbers, the costs we incur, including the servicer and borrower incentive fees, could be substantial. Under HAMP, Freddie Mac will bear the full cost of the monthly payment reductions related to modifications of loans we own or guarantee, and all servicer and borrower incentive fees, and we will not receive a reimbursement of these costs from Treasury. In addition, we continue to devote significant internal resources to the implementation of the various initiatives under the MHA Program. It is not possible at present to estimate whether, and the extent to which, costs, incurred in the near term, will be offset by the prevention or reduction of potential future costs of loan defaults and foreclosures due to these initiatives.
Our Other Recent Efforts to Assist the U.S. Housing Market
• During the nine months ended September 30, 2009, we purchased or guaranteed $444.2 billion in unpaid principal balance of mortgages and mortgage-related securities for our total mortgage portfolio. This amount
included $382.0 billion of newly-issued PCs and Structured Securities. Our purchases and guarantees of single-family mortgage loans provided financing for approximately 1.78 million conforming single-family loans, of which approximately 82% consisted of refinancings. We also remain a key source of liquidity for the multifamily market with purchases or guarantees of mortgages that financed approximately 181,000 multifamily units during the nine months ended September 30, 2009;
• In addition to supporting HAMP, we continued to help borrowers stay in their homes or sell their properties through our other programs. For example, we completed more than 8,000 non-HAMP loan modifications and nearly 18,000 repayment plans, forbearance agreements and pre-foreclosure sales during the third quarter of 2009;
• We have entered into standby commitments to purchase single-family and multifamily mortgages from a financial institution that provides short-term loans, known as warehouse lines of credit, to mortgage originators. In October 2009, we announced a pilot program to help our seller/servicers obtain warehouse lines of credit with certain participating warehouse lenders;
• In October 2009, we announced our participation in the Housing Finance Agency initiative, which is a collaborative effort of Treasury, FHFA, Freddie Mac, and Fannie Mae. Under this initiative, we will give credit and liquidity support to state and local housing finance agencies so that such agencies can continue to meet their mission of providing affordable financing for both single-family and multifamily housing;
• Despite challenging conditions, in October 2009, we completed our second securitization transaction with multifamily mortgage loans this year, which totaled approximately $1 billion;
• We expect to participate in more than 300 foreclosure prevention workshops during 2009, reaching borrowers in more than 25 states nationwide. In the first half of 2009, Freddie Mac contributed nearly $5 million to non-profit organizations to help educate borrowers about their options and prevent fraud. We will be providing additional grants to organizations that are working to support the MHA program. These organizations will assist borrowers in completing HAMP requirements.
Government Support for our Business
We are dependent upon the continued support of Treasury and FHFA in order to continue operating our business. We also receive substantial support from the Federal Reserve. Our ability to access funds from Treasury under the Purchase Agreement is critical to keeping us solvent and avoiding the appointment of a receiver by FHFA under statutory mandatory receivership provisions.
We had a positive net worth at September 30, 2009 as our assets exceeded our liabilities by $10.4 billion. Therefore, we did not require additional funding from Treasury under the Purchase Agreement. However, we expect to make additional draws under the Purchase Agreement in future periods due to a variety of factors that could adversely affect our net worth.
Significant developments with respect to the support we receive from the government include the following:
• The aggregate liquidation preference of the senior preferred stock was $51.7 billion as of September 30, 2009. To date, we have paid total dividends of $3.0 billion in cash on the senior preferred stock to Treasury, at the direction of the Conservator.
• Treasury continues to purchase our mortgage-related securities under a program it announced in September 2008. According to information provided by Treasury, as of September 30, 2009 it held $176.0 billion of mortgage-related securities issued by us and Fannie Mae. Treasury's purchase authority under this program is scheduled to expire on December 31, 2009.
• No amounts have been borrowed under the Lending Agreement as of September 30, 2009. However, we have successfully tested our ability to access funds under the Lending Agreement.
• The Federal Reserve continues to purchase our debt and mortgage-related securities under a program it announced in November 2008. According to information provided by the Federal Reserve, as of October 28, 2009 it had net purchases of $325.6 billion of our mortgage-related securities and held $54.0 billion of our direct obligations. On September 23, 2009, the Federal Reserve announced that it will gradually slow the pace of purchases under the program in order to promote a smooth transition in markets and anticipates that these purchases will be executed by the end of the first quarter of 2010. As discussed below, the slowing of debt purchases by the Federal Reserve and the conclusion of its debt purchase program could adversely affect our ability to access the unsecured debt markets.
It is difficult at this time to predict the impact that the completion of the Federal Reserve's and Treasury's mortgage-related securities purchase programs will have on our business and the U.S. mortgage market. It is possible
that interest rate spreads on mortgage-related securities could widen, resulting in more favorable investment opportunities for us following the completion of these programs. However, we may be limited in our ability to take full advantage of any potential investment opportunities because, beginning in 2010, we must reduce our mortgage-related investments portfolio, pursuant to the Purchase Agreement, by 10% per year, until it reaches $250 billion.
For information on the potential impacts of the completion of the Federal Reserve's purchase program and the expiration of the Lending Agreement with Treasury on our access to the debt markets and our liquidity backstop plan, see "Liquidity and Capital Resources - Liquidity".
For more information on the terms of the conservatorship, the powers of our Conservator and certain of the initiatives, programs and agreements described above, see "BUSINESS - Conservatorship and Related Developments" in our 2008 Annual Report.
Housing and Economic Conditions and Impact on Third Quarter 2009 Results
Our financial results for the third quarter of 2009 reflect the continuing adverse economic conditions in the U.S. During 2009, there have been some positive housing market developments, including higher volumes of home sales and modest improvements in home prices in certain regions and states. However, there have been significant increases in unemployment rates which, coupled with declines in household wealth, have contributed to increases in residential mortgage delinquency rates. We believe that much of the increase in home sales reflects distressed home sales, including higher short sales and sales of foreclosed properties in the market. As a result, we continue to experience significant credit-related expenses. Our provision for credit losses was $7.6 billion in the third quarter of 2009, principally due to increased estimates of incurred losses caused by the deteriorating economic conditions, which were evidenced by our increased rates of delinquency, the significant volume of REO acquisitions and an increase in our single-family non-performing assets.
Home prices nationwide increased an estimated 0.3% in the third quarter of 2009 (and an estimated 0.9% during the nine months ended September 30, 2009) based on our own internal index. However, many regions and states suffered significant home price declines in the last two years. The percentage decline in home prices in the last two years has been particularly large in the states of California, Florida, Arizona and Nevada, which comprised approximately 25% of the loans in our single-family mortgage portfolio as of September 30, 2009. The second and third quarters of the year are historically strong periods for home sales. Seasonal strength along with the impact of state and federal government actions, including incentives for first time homebuyers and foreclosure suspensions, may have contributed to the increase in home prices during the third quarter of 2009. We expect that when temporary government actions expire and the seasonal peak in home sales has passed, home prices are likely to decline over the near term. Unemployment rates worsened in the third quarter of 2009, and the national unemployment rate increased to 9.8% at September 30, 2009 as compared to 9.5% at June 30, 2009. Certain states experienced much higher unemployment rates, such as California, Florida, Michigan and Nevada, where the unemployment rate reached 12.2%, 11.0%, 15.3% and 13.3%, respectively, at September 30, 2009. Loans originated in these states comprised approximately 26% of the loans in our single-family mortgage portfolio as of September 30, 2009. Many financial institutions continued to remain cautious in their lending activities during the third quarter of 2009. Although there was overall improvement in credit and liquidity conditions during the third quarter, credit spreads for both mortgage and corporate loans remained higher than before the start of the recession.
These macroeconomic conditions and other factors, such as our temporary suspensions of foreclosure transfers of occupied homes, contributed to an increase in the number and aging of delinquent loans in our single-family mortgage portfolio during the third quarter of 2009. Beginning in November 2008, we temporarily suspended all foreclosure transfers of occupied homes for certain periods ending March 6, 2009. Beginning March 7, 2009, we began suspension of foreclosure transfers on owner-occupied homes where the borrower may be eligible to receive a loan modification under HAMP. We also observed a continued increase in market-reported delinquency rates for mortgages serviced by financial institutions, not only for subprime and Alt-A loans but also for prime loans, and we experienced significant increases in delinquency rates for all product types during the third quarter of 2009. Additionally, as the slump in the U.S. housing market has lasted over two years, increasing numbers of borrowers that previously had significant equity in their homes are now "underwater," or owing more on their mortgage loans than their homes are currently worth.
The continued weakness in housing market conditions during the third quarter of 2009 also led to a further decline in the performance of the non-agency mortgage-related securities in our mortgage-related investments portfolio. Mortgage-related securities backed by subprime, option ARM, Alt-A and other loans have significantly greater concentrations in the states that are undergoing the greatest stress, including California, Florida, Arizona and Nevada.
As a result of these and other factors, we recognized impairments of available-for-sale securities in earnings during the third quarter of 2009.
Multifamily housing fundamentals deteriorated during the third quarter of 2009, reflecting an increasing unemployment rate and reduced access to credit for individual and institutional borrowers. Partially as a result of home ownership becoming more affordable over the past several years, multifamily properties experienced declining rent levels and vacancy rates rose to multi-year highs. This trend negatively impacted multifamily property cash flows in the third quarter of 2009. Our multifamily delinquency rate was unchanged at September 30, 2009 from 11 basis points as of June 30, 2009, though we expect it to increase during the remainder of 2009. During 2009, we have also seen significant deterioration in the financial strength of certain multifamily borrowers in measures such as the debt coverage ratio and estimated current LTV ratios for the properties.
Consolidated Results of Operations - Third Quarter 2009
Net income (loss) was $(5.0) billion and $(25.3) billion for the third quarters of 2009 and 2008, respectively. Net loss decreased in the third quarter of 2009 compared to the third quarter of 2008, principally due to lower impairment-related losses on mortgage-related securities, higher net interest income, and fair value gains on our guarantee asset and other investment activities, compared to losses on these items during the third quarter of 2008. These income and gains for the third quarter of 2009 were partially offset by increased provision for credit losses, losses on debt recorded at fair value and losses on loans purchased, compared to the third quarter of 2008.
Net interest income was $4.5 billion for the third quarter of 2009, compared to $1.8 billion for the third quarter of 2008. As compared to the third quarter of 2008, we held higher amounts of fixed-rate mortgage loans and agency mortgage-related securities in our mortgage-related investments portfolio and had lower funding costs, due to significantly lower interest rates on our short- and long-term borrowings during the three months ended September 30, 2009. Net interest income during the three months ended September 30, 2009 also benefited from the funds we received from Treasury under the Purchase Agreement. These funds generate net interest income, because the costs of such funds are not reflected in interest expense, but instead as dividends paid on senior preferred stock.
Non-interest income (loss) was $(1.1) billion for the three months ended September 30, 2009, compared to $(11.4) billion for the three months ended September 30, 2008. The decrease in non-interest loss in the third quarter of 2009 was primarily due to improvements in investment activity, which was a gain of $1.4 billion in the third quarter of 2009 as compared to a loss of . . .
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