Richard Bove, vice president of equity research at Rafferty Capital Markets sent an email to clients Wednesday morning calling operations at Freddie Mac “outrageous” on the back of the government-sponsored enterprise posting its first loss in four years.
“This [loss] will force Congress and the courts to come to some decisions about the status of the government sponsored agencies," Bove told clients. "This company is insolvent and playing financial games that are not acceptable. The Treasury is robbing its capital. Yet, it is expected to aid in the financing of the housing market.”
Freddie Mac CEO Donald Layton cited a hedging loss of $4.2 billion as reason for the quarterly results, which Bove takes exception to.
“This is the sixth time in the past seven quarters that the company has reported a derivatives loss,” Bove said.
Sharon McHale, vice president of corporate communications and marketing at Freddie Mac, dismisses the criticism.
"Freddie Mac’s core businesses are strong – volumes are growing and credit quality is continually improving," she said in a statement to HousingWire.
"As we explained in great detail, our comprehensive income loss in the third quarter was driven primarily by an accounting mismatch associated with our use of derivatives to manage interest rate risk," McHale added. "We are extremely prudent in managing this risk, as can be seen in our duration gap measure, which we clearly disclose and which has averaged zero for some time."
“[The loss] is not the real economics going on,” Layton said in a telephone conversation with HousingWire, where he dismissed any accusation of inappropriate risk management. To be fair, the GSE grew its single-family guarantee business 50% annually.
In a statement Layton added: "This $0.5 billion loss was caused mainly by the accounting associated with our use of derivatives, whereby the derivatives are marked to market but many of the assets and liabilities being hedged are not.”
As a result, the difference between GAAP reporting and the actual underlying economics, which has created significant GAAP income volatility in quarterly financial statements, reduced Freddie's after-tax earnings in the quarter by an estimated $1.5 billion as interest rates declined significantly.
Layton noted that is the complete opposite result of the prior quarter, which had a $1.5 billion positive contribution to earnings as rates rose significantly.
"Otherwise, the business had very strong fundamentals with growing volumes of guarantees and continued improving credit quality in the guarantee businesses,” said Layton.
Bove is not convinced this may be enough to improve performance at Freddie Mac.
“Freddie Mac has no common equity," Bove said. "Its total equity is $1.3 billion on a balance sheet that is $1.96 trillion in size. Another after-tax loss like the one in the third quarter will wipe out the company’s equity."