- Bottom line hit by accounting for hedges on interest-rate risk
- FHFA's Watt points to increasing likelihood of future draws
Freddie Mac moved closer to needing another dose of U.S. Treasury Department aid after reporting its first quarterly loss since 2011 stemming mostly from accounting for hedges against interest-rate risk.
The company, which has operated under federal conservatorship since it was seized along with rival Fannie Mae in 2008, had positive net worth of $1.3 billion after a half-billion dollar loss for the third quarter, according to a statement released Tuesday. That means it won’t need to add to the $71.3 billion in aid it has received since the financial crisis or the $96.5 billion it has sent to Treasury after regaining profitability in 2012.
Freddie Mac uses derivatives to manage its exposure to interest-rate risk, which can create volatility that doesn’t necessarily reflect the underlying economics of its business. In the third quarter, the company had derivative losses of $4.2 billion, mainly due to accounting treatment for hedged assets and liabilities as interest rates declined.
“Derivatives create a large source of GAAP earnings instability despite the underlying economics being all about reducing interest-rate exposure of the company to very low levels, which is what we are told to do economically,” Freddie Mac Chief Executive Officer Donald Layton said in a telephone interview.
Net Worth Threshold
Under conservatorship, Freddie Mac and Fannie Mae are required to turn over to Treasury all profits above a minimum net worth threshold. The payments count as a return on the U.S. investment and not as a repayment for the bailout, leaving the companies with no mechanism to leave government control.
“Freddie Mac’s reported quarterly earnings loss is accounting driven and does not reflect a deterioration in the underlying health of its business,” Rob Runyan, a Treasury spokesman, said in a statement. “Nevertheless, the prospect of any material losses by the GSEs is another reminder that comprehensive housing finance reform is necessary.”
White House housing adviser Michael Stegman in September dismissed investor calls to release Fannie Mae and Freddie Mac. He said he is sticking to keeping them under U.S. control and doesn’t see a path out of conservatorship any time soon.
“Freddie Mac’s financial disclosures have consistently highlighted how accounting rules and changes in interest rates could negatively affect their quarterly earnings,” Federal Housing Finance Agency Director Melvin Watt said in a statement. Interest-rate volatility and bailout terms that will reduce their capital buffers to zero in 2018 make Freddie Mac and Fannie Mae “increasingly susceptible to the possibility of quarterly losses that could result in draws going forward,” said Watt, whose agency oversees the two companies.
The heads of both companies were granted pay increases in July from a flat $600,000 to as much as $4 million a year, after FHFA authorized the raises. The Senate passed legislation in September that would restore the executives’ pay at the previous levels. The House is expected to approve a similar bill this month.
“We can’t simply put the blinders on and say that Fannie and Freddie are just like other companies when taxpayers are on the hook if they go in the red,” said Representative Ed Royce, the California Republican who is sponsoring the House bill to cap the CEO pay.
Investors Unite Executive Director Tim Pagliara, whose group has challenged the terms of the U.S. conservatorship, said the quarterly loss reinforces the need to let Freddie Mac and Fannie Mae retain capital.
“There will always be down quarters, and Freddie Mac has reported this as an accounting loss, not a reflection of any negative changes to its core business,” Pagliara said in a statement. “The fact remains that Freddie Mac has paid back the taxpayers $96 billion after being loaned $71 billion in 2008.”