Federal Home Loan Mortgage Corporation (FMCC) Earnings Call Transcript & Summary

Good morning ladies and gentlemen and welcome to the Freddie Mac Fourth Quarter and Full Year 2019 Financial Results Media Conference call. [Operator Instructions]. I would now like to turn the conference over to your host, Mr. Jeffrey Markowitz, Senior Vice President of External Relations and Corporate Communications.

Good morning, and thank you for joining us for a discussion of Freddie Mac's Fourth Quarter and Full Year 2019 Financial Results. We're joined today by the company's CEO, David Brickman; Interim CFO, Donald Kish; CAO, Jerry Weiss; and General Counsel, Ricardo Anzaldua. Before we begin, we'd like to point out that during this call, Freddie Mac executives may make forward-looking statements, which are based on a set of assumptions about the company's key business drivers and other factors. Changes in these factors could cause the company's actual results to vary materially from its expectations. A description of these factors can be found in the company's annual report on Form 10-K filed today. Freddie Mac executives also may discuss non-GAAP financial measures. For more information about those measures, please see our earnings press release and related materials, which are posted on the Investor Relations section of freddiemac.com. Our commentary today will be limited to business and market topics. As you know, we cannot comment on public policy or legislation concerning Freddie Mac. As a reminder, this call is for the media, and only they can ask questions. It is being recorded, and a replay will soon be available on freddiemac.com. We ask that the call not be rebroadcast or transcribed. With that, I will turn the call over to Freddie Mac's CEO, David Brickman.

Thank you, Jeff. Good morning, and welcome to our fourth quarter and full year earnings call. I'm excited to recap the significant progress our company made in 2019 and share with you some of the big developments we're working toward in the year ahead. Today, I'll touch on 3 topics. First, our financial performance over the course of 2019; second, the progress we have made to further Freddie Mac's role as a leader in housing; and third, our current thinking about the housing market in 2020. I'll conclude by discussing how all this relates to our primary focus: preparing to responsibly exit conservatorship. Let me start with our financial performance. We ended 2019 with a very strong fourth quarter, recording $2.4 billion of comprehensive income. This was a $0.6 billion increase over the prior quarter. For the year overall, Freddie Mac saw continued solid earnings with strong returns and a decline in the amount of capital necessary to manage our risks. Specifically, our comprehensive income in 2019 was $7.8 billion, down $0.8 billion from 2018. The company's modest drop in income is largely attributable to 3 factors. First, the low interest rate environment reduced net interest income on our investment portfolio. Second, guarantee portfolio amortization income decreased, product of timing differences between when we receive the proceeds from loan prepayments and the remittance of those proceeds to security holders. This partially offset otherwise strong business revenue. And third, the investments we made to reduce our risks and make our business more efficient increased our costs. I'll elaborate on some of those investments later in my remarks. In addition to these factors, I note that other income was lower in 2019. This is due in part to a $0.3 billion judgment we obtained in 2018, and we do not receive a similar judgment in 2019. Our return on conservatorship capital remained relatively unchanged from 2018 at a strong 15%. This proxy for return on equity is a good indication that our company is maintaining a consistent and stable risk-adjusted return. It is also evidence of our strength as a well-managed financial institution that is making good decisions in the best interest of taxpayers. In addition, we continue to demonstrate our core strength as a risk manager, most notably due to a decline of $4.8 billion in the amount of conservatorship capital needed to support our business. This can largely be attributed to credit risk transfer activity, home price appreciation and the disposition of legacy assets as well as a decrease in deferred tax assets. This reduction, combined with the continued strong and stable credit performance in our mortgage business, illustrates the strength of our risk culture. Let me note one additional item in terms of financial performance related to the implementation of the Financial Accounting Standard Board's new Current Expected Credit Loss accounting known as CECL. I can report that we expect to recognize a nonmaterial decrease to retained earnings of $0.2 billion upon CECL's adoption on January 1, 2020. Finally, in 2019, we executed on what matters most at Freddie Mac, our mission of providing liquidity, stability and affordability to the housing market. In fact, over the course of the year, we held nearly 2.6 million families to own or rent a home by providing nearly $558 billion in funding to the mortgage market. We served approximately 950 regional and community-oriented single-family lenders. We purchased nearly 1.8 million home loans, including loans to nearly 395,000 first-time homebuyers, and we financed 809,000 rental units, 94% of which were affordable to families earning at or below 120% of area median income. Beyond these numbers, 2019 also marked a year of evolution as we continued to transform our company to be the leader in housing across a number of dimensions. That evolutions includes the successful launch of the Uniform Mortgage-Backed Security, or UMBS; our continually evolving credit risk transfer programs and advancements in our internally and externally focused technology. Launched in June, the UMBS is one of the most important developments in housing finance since our founding. In a short time, we have seen more than $27 trillion, that was trillion with a "T", dollars of securities traded in the combined to-be-announced, or TBA, market. The tremendous volume of trading on the new UMBS has enhanced secondary market liquidity, which should ultimately lower mortgage costs for homebuyers. Our pioneering credit risk transfer, or CRT, programs achieved new heights in 2019, surpassing $50 billion of single-family credit risk transferred from Freddie Mac to investors. The percentage of our single-family credit guarantee portfolio and the percentage of our multifamily mortgage portfolio covered by credit enhancements or risk transfers increased to 56% and 89%, respectively, as of December 31, and we continued to find new innovative ways to move more risk to the private sector last year. For example, in single family, we introduced a new offering that transfers additional first-loss risk that our company previously retained. And in multifamily, we launched our first ever K-Deal with a class of securities tied to the new Structured Overnight Finance Rate, or SOFR, the index, which is expected to replace LIBOR over the next 2 years. We also made progress in our ongoing digital transformation in 2019, helping to improve our efficiency and increase our operational risk. We have made significant investments in improving our technology, adding new collaboration and productivity tools that have changed the way we work as a company. We also adopted an agile environment for product development that brings IT and business together to be faster, smarter and more collaborative. The results include integrated software applications, such as our single family's asset and income modeler, or AIM, which automates the process of borrower data verification. AIM makes it possible for lenders to close loans faster and creates a better financing experience for homebuyers. The automation of this process also helps to remove subjectivity from borrower asset and income assessments, reduces errors and allows us to calculate risk more easily and accurately. Our multifamily business is also driving toward a digital platform. We recently introduced a digital inspection application that allows inspectors to use a mobile device to digitally record inspection observations, including photos, decreasing potential operational and credit risk for Freddie Mac. In addition, we've ramped up our industry-leading research to help more families. Our efforts range from economic outlooks and insight [Audio Gap] aspect of the housing market to attitudinal research on the changing preferences of today's renters and owners. In fact, we recently released a landmark study on Generation Z, the large population cohort born since the mid-1990s, the generation after generation -- after the millennials, excuse me, which will profoundly influence our industry over the next few decades, in which I find particularly interesting given I'm the parent of 3 generations Z'ers. Looking ahead, the actions we took in 2019 helped to prepare us for the environment we expect in 2020 and beyond. So what do we see coming? We expect mortgage rates to remain low over the next 2 years, which will continue to fuel purchase demand and bring modest market growth. We project home sales will increase steadily from 6 million in 2019 to 6.3 million in 2021, while home price growth should decelerate. We believe we'll continue to climb at an annual rate of 2.8% in 2020. The optimistic outlook for growth of the market and home price appreciation, unfortunately comes with a downside as supply continues to tighten. The nation's housing stock is suffering. The United States added 9.8 million housing units in the last decade compared to an average of 18 million per decade over the last 50 years. Even the 10-year high of 1.3 million units delivered in 2019 fell short of an annual housing demand by about 300,000 units, exacerbating an already significant supply deficit from prior years and contributing to the growing affordability crisis. These economic factors underscore the urgency of our top strategic priority as a company, exiting conservatorship responsibly. I would also note that in 2020, we, as a company, will be expanding and increasing our focus on sustainability and ESG issues more broadly. You will see some commentary about in the 10-K this year and look for us to have more to discuss over the course of the year. I'll just close with the topic of our preparation to exit conservatorship. FHFA Director Calabria has said that ending conservatorship will move us toward a mortgage finance system that meets the housing needs of American families, protects the American taxpayer and supports financial stability. We support those goals. Like Director Calabria, we believe that exiting conservatorship will help us identify new opportunities to lower the barriers to creating, preserving and financing quality housing. We also believe it will enable us to identify market opportunities to incentivize private capital to invest in affordable housing solutions. We took some significant steps in 2019 to help prepare for our exit. Importantly, we built an additional $4.6 billion in total equity, bringing our capital buffer to $9.1 billion as of December 31. FHFA took another significant step in the past few days, announcing it has selected a firm to advise it on a potential capital raise. We hope to actively begin a search for our own financial adviser in the coming weeks, and we hope to report on our progress on that in the near future. We also look forward to FHFA finalizing a capital rule that will provide guidance on our target capital level and set yet another milestone on the path at exiting conservatorship. I want to close by reiterating something I mentioned in the last earnings call. FHFA will set out the milestones on the path to exit from conservatorship, but how fast we achieve them is up to us. As a company and as individuals, we at Freddie Mac are committed to that goal and achieving it responsibly. We believe our mission requires it. That concludes my prepared remarks. I thank you all for your time, and I'm happy to take any questions.

[Operator Instructions]