Freddie Trying to Find the Balance in Credit-Risk Deals

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WASHINGTON — Freddie Mac's credit risk transfers come with a hefty price tag, but are ultimately still worth it, according to Chief Executive Don Layton.

The government-sponsored enterprise has completed nearly $182 billion in credit risk transfers in which a portion of its credit risk is absorbed by a third-party company either before or after the mortgages are closed. The interest and premiums the GSE pays on the transfers effectively reduced Freddie's guarantee income by roughly 33% for the transactions executed through Sept. 30.

In an interview, Layton said that such a deal still makes economic sense for Freddie under certain conditions.

"Credit risk transfer is an efficient and good thing to do on its own, if the income you give up is relatively small verses the reduction in risk," Layton said. "The calculations for determining the benefits of a deal are internal and not visible to the outsiders. We deal with our regulator to make sure these calculations are reasonable, and that is our guiding light."

Layton noted that determining a good deal is a balancing act.

"If we have to give up too much income, the taxpayer is better off sitting on the risk. If we give up a little income, the taxpayer is better off, while the earnings are lower, the risk and capital support they give to us is more proportionally," he said.

So far, Freddie has experienced minimal writedowns on its Structured Agency Credit Risk debt notes and few claims have been filed for losses.

Freddie's experiments with credit risk transfers come as the industry has divided feelings over the transactions. The banking industry largely supports back-end deals, which occur after the loans that are part of the deal are already closed, but community bankers fear that front-end deals will leave them unable to compete with larger players. They are concerned that Freddie and Fannie Mae would be willing to cut deals on guarantee fees to win over large originators, while smaller players are left out in the cold.

The Federal Housing Finance Agency recently sought industry input on how to address the deals. Many see the experiments as paving a path toward a future housing finance system.

For now, Freddie's financials are strong. The GSE benefited from strong refinancings during the third quarter, helping to boost net income to $2.3 billion, up from $993 million in the second quarter and a $475 million loss a year earlier.

"The core business at the GSEs is fundamentally strong. The primary risk for the GSEs at this point is political in nature as a draw could foster uncertainty in both Washington and Wall Street," said Isaac Boltansky, a policy analyst at Compass Point Research & Trading.

The two GSEs are also prepped for higher interest rates should the Federal Reserve opt again to raise rates this year. Higher rates should reduce the GSEs' hedging costs and make them more profitable.

"If interest rates start to rise, that is favorable to the GSEs," said Rob Zimmer, a principal at the Washington consulting firm TVDC.

Some also see the multifamily market, which has recently had a strong run, as a potential source of concern going forward. But Layton downplayed those fears.

"Multifamily vacancy rates have flattened out and rents are still going up but not as fast," he said. "We don't see any particular negatives yet. We see the market doing fine, just not as strong as it has been."

However, "looking at other asset classes that are starting to struggle" is making "us little bit cautious," Layton said.

Freddie will pay a $2.3 billion dividend to the U.S. Treasury in December under its senior preferred stock agreement. The GSE did not pay a dividend last December because of the $475 million loss.

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