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5-TAKEAWAYS ON FANNIE, FREDDIE EARNINGS

Mortgage giants Fannie Mae and Freddie Mac are sending $10.2 billion to the U.S. Treasury after reporting combined first-quarter profits of $9.3 billion.

But Thursday’s earnings reports hinted at a possible cooling off in the profits of both companies, which have benefited from large one-time gains over the past several quarters. They also suggested a modestly softer housing demand. Here are five takeaways:

8 MAY 2014 6:17PM

BY 

NICK TIMIRAOS 

CONNECT

• 1BIG ONE TIME GAINS

  Fannie reported pre-tax income of $7.9 billion, of which $4.1 billion came in legal settlements that aren’t likely to be repeated. Freddie reported pre-tax income of $5.8 billion, with $4.9 billion in legal settlements.

  In recent quarters, the companies have also benefited from a big rebound in home prices. The rebound has allowed them to release reserves as expected losses failed to materialize and to reclaim certain tax benefits that had been written down in 2008. The tax benefits alone accounted for roughly half of profits last year. Executives at both firms acknowledged that earnings in 2014 were likely to be substantially lower than last year.

  Nevertheless, Fannie and Freddie will have sent $213 billion to Treasury by the end of June, around $26 billion more than the amount the Treasury sunk into both companies.

  

• 2SHIFTING BUSINESS

  The companies are also facing much lower mortgage production volumes after the number of homeowners refinancing their mortgages plunged following last summer’s jump up in interest rates.

  Fannie and Freddie’s core businesses consist primarily of two activities: insuring mortgages that are packaged into bonds, and investing in mortgages directly. The latter business, once the source of huge profits but also greater volatility, is being wound down. The loan-guarantee business will account for a greater part of the business going forward, and some analysts say guarantee fees would need to rise to make that business more attractive to private investors who have argued that the firms should be recapitalized.

  If Freddie faced capital standards comparable to what exists for other large banks or insurance companies, loan-guarantee fees today would “earn a return that is less than what private investors would want by a modest amount,” said Donald Layton, the company’s CEO.

  

• 3SOFTER HOUSING

  Fannie’s inventory of foreclosed homes grew from the year-earlier level for the first time since 2011. Though the 102,398 foreclosed properties it held at the end of March was down slightly from the end of last year, it was up 0.9% from a year earlier, a sign that there has been less demand from buyers at current prices. “The level of activity has declined somewhat,” said Fannie CEO Timothy Mayopoulos on a call with reporters Thursday. Investors, which had been scarfing up foreclosed homes, have retreated because “there aren’t as many bargains out there as there used to be,” he said.

  On average, Fannie sold foreclosed homes for 73.8% of the underlying loan balance during the first quarter. That was up from 70.6% a year earlier but down for the second straight quarter.

  • 4CREDIT THAW

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    Lenders have begun to ease credit standards slightly as loan production falls. Banks, though, are being “thoughtful and cautious in how they go about doing that,” said Mr. Mayopoulos. “The loans that people are delivering to us are of very high quality,” he added. The average credit score backed by Fannie stood at 740 at the end of March, down from 751 a year earlier. Some 1.8% of loans backed by Fannie had credit scores below 620, compared to 1% two years earlier.

    740

    The average credit score backed by Fannie at the end of March.

  • 5NO CAPITAL BUT CHEAP BORROWING

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    The terms of the companies’ government backing require Fannie and Freddie to send almost all of their profits to the Treasury, though they don’t owe anything if they run a loss. Investors have sued the companies to challenge those terms, which have depleted them of capital. The arrangement, which took effect last year, has created “a challenging situation for us,” said Mr. Mayopoulos. “We are running a $3 trillion balance sheet with very, very little capital retained earnings.”

    Meanwhile, a top Treasury adviser gave a speech Thursday to remind investors that much of what Fannie and Freddie have done wouldn’t be possible without such extraordinary government assistance. Not enough attention is paid “to the extraordinary value of Treasury’s continued capital support which allows the [companies] to borrow at very low cost, more akin to sovereign rates than those of a private company issuing corporate debt,” said Michael Stegman, the adviser, at a conference for municipal-bond analysts in Orlando.

    

    Bloomberg

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