Freddie Mac Chief Executive Donald Layton insisted Tuesday that the government-sponsored enterprise showed "very strong fundamentals" in the third quarter, despite reporting a $501 million loss due to an accounting mismatch with its use of derivatives.
It was the enterprise's first quarterly loss in four years, compared to a net income of $2.8 billion a year earlier, but it will not force Freddie to request a draw from the U.S. Treasury.
Layton tried to dismiss the importance of the loss, saying that the company's fluctuations in derivatives gains and losses have created "income volatility in our quarterly financial statements," which tends to result in an accounting mismatch.
But critics on Capitol Hill and elsewhere were not buying it.
Rep. Ed Royce, R-Calif., warned that Freddie's loss was an imminent threat to taxpayers. (Under the conservatorship, Freddie cannot retain capital, and will have to go to Treasury if it suffers a serious loss.)
"Losses like this combined with multimillion dollar CEO salaries at the GSEs are the warning shots of a return to the pre-crisis model of private gains and public losses that wrecked the economy," Royce said in a press release. "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."
Royce has introduced legislation to reform Fannie Mae and Freddie, including limiting the total CEO compensation at the GSEs to $600,000 a year each.
Despite the heated political rhetoric, Freddie tends to lose money on derivatives when interest rates decline, and could receive a significant boost if the Federal Reserve begins raising interest rates again.
Mel Watt, the director of the Federal Housing Finance Agency, which oversees Freddie and Fannie, said Freddie's "strong business results" in the third quarter "more than offset losses associated with managing the company's interest rate risks."
"Freddie Mac's financial disclosures have consistently highlighted how accounting rules and changes in interest rates could negatively affect their quarterly earnings," Watt said in a statement, noting that Freddie's third quarter loss "was not due to a decline in credit quality or an increase in credit related losses."
The GSEs are required to reduce their retained portfolios and transfer credit risk away from taxpayers to the private sector, which will also reduce overall revenues.
Watt said the volatility in interest rates combined with a capital buffer that will decline to zero in 2018 under terms of their agreements with Treasury will make both GSEs "increasingly susceptible to the possibility of quarterly losses that could result in draws going forward."
Jim Vogel, an executive vice president of interest rate strategies at FTN Financial in Memphis, said Freddie and Fannie are doing three things to lower risk: increasing their core profitability, reducing legacy assets and engaging in more risk-sharing.
"Everything is working exactly as Treasury designed it," Vogel said. "So concentrating on payments back and forth in one quarter should not be a substantive issue."
But he cautioned that even strong mortgage growth in Freddie's single family business cannot keep pace with rising expenses and price pressures.
In a research note to clients, Vogel wrote that although Washington policymakers "swear by GAAP numbers — no 'funny' stuff like before — few anywhere can comprehend what a hash GAAP creates for financial institutions with thin operating cushions."
Freddie's third-quarter loss reflected two market-related items: a $1.5 billion loss on the value of derivatives used to hedge the company's interest rate risk, and a $600 million loss due to credit spread changes on various assets and liabilities measures at fair value.
A quarter earlier, Freddie posted nearly the opposite results, with a $1.5 billion fair value gain in derivatives and a $700 million gain on credit spreads.
Freddie Mac and Fannie Mae were put into conservatorship in 2008 during the financial crisis. Freddie has paid $96.5 billion in dividends to the Treasury as of Sept. 30 — more than the $71.3 billion in bailout support it has received from taxpayers.
In a sign that the housing market has strengthened, Freddie posted a 50% jump in purchase volume in the first nine months of the year, to $275 billion compared with $184 billion in the same period a year earlier.
Freddie's purchase volume fell 7% in the third quarter to $94 billion, split almost equally between home purchases and refinances. In the second quarter, refinances made up 62% of total funding volume of $101 billion.
Credit quality also improved. Freddie's serious delinquency rate fell to 1.41% in the third quarter, the lowest level since October 2008.
Freddie reported $3.7 billion in net interest income in the third quarter, up slightly from a year earlier.