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Leland C. Brendsel
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Last year clearly demonstrated that Freddie Mac's success in serving America's homebuyers and renters, and our success in delivering strong financial results, go hand in hand. We cannot achieve one without the other. It is not a balancing act; they are joint. When homebuyers do well, and when we serve our mission well, we deliver strong financial results.
I expect 2002 to be an excellent year, with solid performance in nearly all parts of the housing market. Home sales and home starts, although down a little from the record numbers in 2001, will still be very strong this year. The underlying fundamentals of low mortgage rates, high housing affordability and steady growth in residential real estate values mean few credit problems and another active year in the mortgage market that Freddie Mac serves. The most recent numbers continue to show vibrancy in the housing sector of the economy.
Today, I want to look beyond last year, to a longer-term outlook for Freddie Mac's future, and what you can expect over the rest of this decade. I certainly think that Freddie Mac is in a strong position to continue our growth and success and to maintain our role as a cornerstone of America's highly successful housing finance system, which is the best in the world.
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- First, Freddie Mac's future rests on a solid foundation - our
market and financial positions are strong.
- Second, Freddie Mac is a leader in a large and attractive market
- the market for U.S. residential mortgage debt. This market will
continue its steady, consistent growth, reflecting the underlying
fundamentals that are driving the growth of mortgage debt outstanding.
- Third, Freddie Mac has built several unique core capabilities that position us as a low-cost, most reliable way to finance housing and that will enable us to continue to grow faster than the underlying mortgage market in the United States.
These factors give us excellent prospects for growing earnings, for maintaining our financial strength and for creating shareholder value. Let me discuss each of these three significant factors underpinning Freddie Mac's future success, beginning with the solid foundation from which we start.
Solid Foundation
For 30 years, ever since we were chartered in 1970, Freddie Mac has worked to reduce costs and to make it easier for families to get a mortgage loan of their choice. In the process, over these 30 years we have financed homes for 30 million families. By providing an uninterrupted supply of low-cost mortgages, Freddie Mac has helped make the U.S. housing finance system the envy of the world and a pillar of the U.S. economy.
Never was the mission of Freddie Mac more important to financing
housing than was evident in 2001. This was a year in which our nation
renewed its focus on family and the core value of one's own home,
which was reinforced after the tragic events of September 11. And
this was also a year in which housing was a source of significant
strength to the economy.
Freddie Mac financed a record number of first-time homebuyers in
2001. We set records in providing mortgage credit for the purchase
and the refinancing of a home. And over 50 percent of our business
in 2001 financed housing for low- and moderate-income families.
The support we provided to the market last year sustained a strong
housing sector and helped buffer the weakening economy.
Fulfilling our housing mission, like we did in 2001, is how Freddie Mac earns and keeps our strong bipartisan support in Congress. Housing is and will remain a national priority. Freddie Mac has demonstrated the benefits that we bring to achieving this nation's goal. In his recent State of the Union Address, President Bush called for "broader homeownership, especially among minorities." Freddie Mac applauds this vision, we support it and we will continue to make it a reality.
Together with our record of fulfilling our housing mission is a
record of solid financial performance. Over the past ten years,
Freddie Mac's earnings per share have grown an average of 19 percent
per year. And our return on equity has consistently exceeded 20
percent.
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Freddie Mac delivered double-digit earnings growth over the past decade despite volatility in interest rates and economic downturns, particularly severe regional downturns. As the line on this chart illustrates, 10-year Treasury rates ranged from 8 percent down to 4 percent since the early 1990s. At the same time, our earnings per share, as indicated by the bars on the chart, have increased steadily. These earnings represent real value that has been created. We generated this exceptional growth while carefully managing both credit and interest-rate risk - the two principal risks of investing in and funding mortgage loans. This was evident in 2001, a year of heightened volatility and market dislocation.
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As we enter 2002, Freddie Mac's financial condition is rock-solid. The credit quality of our mortgage portfolio is the strongest in over a decade. Credit losses were less than one basis point of our total mortgage portfolio in 2001, and the portfolio is well protected against future weakness in the economy. The average current loan-to-value ratio of our mortgage portfolio is about 60 percent. This means we have about $600 billion of homeowner equity protecting us from loss. In addition, about one-third of our mortgage portfolio is credit enhanced with mortgage insurance, recourse to lenders and other arrangements that mitigate loss, particularly on high-risk loans. Finally, our credit portfolio is geographically diversified across the nation, which helps protect against regional downturns.
We enter 2002 with our retained portfolio very well protected against interest-rate volatility. We expect to see solid growth in our retained portfolio. Our primary indicator of interest-rate risk is our Portfolio Market Value Sensitivity, or PMVS, which we disclose monthly. Currently it is about 3 percent. To put this in perspective, a 3 percent PMVS corresponds to a duration gap of less than one month. About two-thirds of our portfolio is protected by option-embedded instruments. We have a high degree of optionality in our liability structure. Freddie Mac has perhaps the lowest interest-rate risk position of any major mortgage investor. Our public disclosures let you judge for yourself. We work to provide timely and comprehensive information about all of our business and financial activities and risk positions.
We also start 2002 with a sound housing market. Home prices continue to move up in every region of the country and housing affordability remains high in our sector of the market, the broad, mainstream market for properties purchased by low-, moderate- and middle-income families. There may be talk about a bubble in higher-end properties that has burst or may burst. In our looking at the market we participate in, there is no bubble ready to burst. Unlike past periods of economic softness, housing inventories remain tight with few signs of overbuilding.
In short, all elements are in place for us to deliver solid growth
in the future. We are starting from a strong foundation. The future
growth opportunities we will have begin with the mortgage market
that we serve and the growth in that market. Let's talk about that.
Mortgage Market Growth
Freddie Mac is at the center of the U.S. residential mortgage market.
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U.S. mortgage debt outstanding currently is just over $6 trillion. Almost $5.5 trillion of that is conforming mortgage debt - below the conforming mortgage balance - the market in which Freddie Mac operates. Mortgage debt outstanding has grown every year since World War II, including times of economic boom and bust. In 2001, mortgage debt outstanding grew 10 percent, even while the economy slowed.
It's tough to find a better market than the one in which we participate. And it keeps growing, keeps getting better. In fact, during this decade, our own estimates indicate that the growth rate of mortgage debt outstanding will be between 7 and 9 percent per year.
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Mortgage debt will grow because more families will becomes homeowners; they will continue to buy larger homes with more amenities as has been the trend; and they will finance a greater share of their homes' value.
Population growth and changing demographics will drive an increased number of households. We expect the nation's homeownership rate, which currently stands at 68 percent, to rise above 70 percent by the end of the decade. The greatest increase will come from increased homeownership among minority and immigrant households. I am impressed with the strength of the desire to own one's own home. One recent survey found that immigrant families are three times more likely than other families to make homeownership their highest personal priority.
Rising home prices will also drive increases in mortgage debt outstanding. Nationwide, home prices have increased every year for the last half-century. We expect this to continue into the 21st century. Between larger homes and underlying inflation, home prices will grow 4 to 5 percent per year over the next decade - a conservative estimate, I think.
Finally, mortgage debt outstanding will grow as families finance more of their homes. We expect large numbers of first-time buyers, who typically borrow more of their homes' value. In addition, mortgage credit is a low-cost, efficient way for families to obtain credit to meet their borrowing needs compared to other types of consumer credit.
Clearly, Freddie Mac is at the center of a market that is exceptionally
well positioned for sustaining strong, steady growth. Seven to 9
percent average annual growth in mortgage debt outstanding means
that it will double to over $12 trillion by 2010.
Unique Core Business Capabilities
Now let's turn to Freddie Mac's unique core business capabilities. Freddie Mac's strong financial and market positions and the underlying growth in the mortgage market provide us with great opportunities. How will Freddie Mac capture them, maintain our position and grow our position in the market?
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Freddie Mac possesses unique business capabilities that will enable us to capitalize on the opportunities and, in fact, to generate growth faster than the market.
Freddie Mac's reliable access to low-cost funds is a capability that enables us to provide competitive bids for mortgages, even during periods of market disruption or turmoil.
Freddie Mac is steadfast in our pursuit of a steady supply of low-cost funds. We have a wide range of financing vehicles that we use to finance mortgages. We pioneered mortgage-backed securities. We were instrumental in developing the market for callable debt. Both are important vehicles for financing long-term fixed-rate mortgages. Now we continue not only to improve those markets, but also to find ways to reduce funding costs by broadening and deepening the universe of investors in our Reference BillsSM and Notes - our bullet debt securities.
Our security offerings are large, they are liquid and they are high quality. They fit perfectly with the investment requirements of an ever-broadening array of investors - domestic and worldwide. Five years ago only about 5 to 10 percent of our debt was distributed overseas. Now it's more than 35 percent. And I expect it to continue to increase. Certainly, we have broadened our name and acceptance overseas in the last few years. I regularly travel overseas to help introduce the Freddie Mac name to more investors. Freddie Mac's reliable access to low-cost funds gives us a competitive edge in the mortgage market, and we believe that competitive edge will continue and possibly be even greater tomorrow.
Freddie Mac also has virtually unparalleled mortgage expertise as a core capability. We have had a singular focus on residential mortgages for 30 years. We have access to nearly 30 years of mortgage information on the 28 million single-family loans we have purchased - on the characteristics of those loans, their performance in every market across the nation under a variety of economic conditions. And we have a team of specialists, of mortgage professionals built over years that gives us an unequaled understanding of this asset class. This expertise puts us in an optimal position to expertly manage both credit and interest-rate risk - the two principal risks involved in the mortgage business.
Our expertise gives us an edge in making mortgage investment decisions, in understanding value for our retained portfolio as well as for our credit business. And it helps us design and pursue sound asset and liability management and hedging strategies to protect portfolio value, to protect income. We invest in mortgages only when they meet our return requirements and only when we can prudently manage their interest-rate and credit risk. Our goal at Freddie Mac is to generate durable, predictable long-term returns.
To do this in our retained portfolio we rely on callable debt and
other instruments, including interest-rate swaps and options. Our
ability to effectively manage the interest-rate risk of our retained
portfolio in the future is supported by the growing variety of techniques
available to us. The choices available to us will provide ongoing
flexibility in executing our interest-rate risk management strategies,
as they have in the past.
In using derivatives - the few types that we use including options,
swaps and interest-rate futures - we seek to eliminate counterparty
risk. We do business with only the highest rated counterparties.
We also impose netting requirements on all of our counterparties.
We mark-to-market daily all of our derivative positions, and we
require high-quality collateral, including cash and Treasury securities,
to be posted against any exposure.
Freddie Mac's financial performance is a testament to our risk management and discipline. Our earnings have grown through a variety of challenging interest-rate environments, including the most recent one of 2001.
Our expertise in managing and understanding mortgage credit risk also continues to grow and to drive innovations. It is why we are in an optimal position to decide when to take on credit risk and when to lay it off with others, which we do very frequently. As I cited earlier, about one-third of our mortgage portfolio is credit enhanced with third parties.
We have also harnessed our credit risk management knowledge and expertise in the form of new technology to expand our market and manage credit costs. Our Loan Prospector® automated underwriting system, which we introduced in 1995 and continue to develop every year, has now become an integral part of how mortgages are originated and underwritten. It has revolutionized how mortgages are made. And enhancements to this system are expanding our reach into the mortgage market and helping us continue to carefully control credit costs. We scored over 7 million loans using Loan Prospector in 2001. About two-thirds of our business was underwritten using Loan Prospector before we purchased the loans. Indeed, all loans we purchase are scored using Loan Prospector tools either before or after we buy them, so that we clearly understand what we've got.
We also are using the same type of technology to reduce the cost of problem loans on the back end - the small proportion of loans that become problems because borrowers are not able to make payments. Technology enables quick intervention to manage those situations. We can identify the most serious delinquent loans sooner with this technology, and we can more effectively assess the feasibility of lower-cost loss mitigation alternatives. A problem loan that is modified through our loss mitigation process has only about 20 percent of the losses of a loan that goes into foreclosure.
Freddie Mac's expertise in understanding and managing credit risk is why our credit performance leads the industry. Our delinquency rates for loans 90 or more days past due currently are only two-thirds of mortgage industry delinquency benchmarks and obviously only a small fraction of what you find in the so-called subprime market segment or the FHA/VA market.
In addition to reliable access to low-cost funds and our unparalleled mortgage expertise, the broad scope of our operations also positions us for growth. The size of our business offers tremendous economies of scale.
Our administrative expenses in total are about 8 basis points of our $1 trillion total mortgage portfolio. And we generate about one and a half million dollars of revenue per employee. Both figures are superior to almost every other major participant in the mortgage market. We are a very efficient intermediary between the end investor on one side and the homeowner on the other.
Freddie Mac maintains a continuous presence in the mortgage market, standing between thousands of lenders and thousands of debt and mortgage investors. This gives us unique access to information and access to mortgage loans and financing opportunities at all times in all markets, so we can capitalize on opportunities when they arise.
Lastly, Freddie Mac's efficient capital structure is also important in enabling us to capture a greater share of the mortgage market. We have capital that is very much tailored to the risks involved in the mortgage business.
We are in one line of business - investing in mortgages on people's homes. This is one reason why it is relatively easy to understand the risks of Freddie Mac and why it is possible to design a capital standard for us. Mortgages are high-quality assets; they should have low capital requirements. They are backed by homeowner equity. We use credit enhancements and other hedging instruments to distribute much of the remaining risk to others. Our capital requirements should reflect that and they do. Our capital requirements - both the ones we use ourselves in understanding how to allocate capital as well as ones in the process of finalization by our regulator - will assure that we hold capital against the risks that we take. We have a very efficient capital structure that means we can be a premier, low-cost funder of residential mortgage credit.
These unique capabilities - low-cost funds, unparalleled mortgage expertise, economies of scale, and efficient capital structure - are real; they are important; and they are sustainable. Each gives us a strong position in competing for mortgage assets. Collectively they are an extremely powerful force for growth above and beyond the 7 to 9 percent growth in the underlying mortgage market per year.
But strong, sustainable capabilities don't guarantee the above-market growth we expect. There needs to be room in our market for us to bring these capabilities to bear. And in each of our two principal businesses, our retained portfolio and our credit portfolio, there is plenty of room for us to grow our share of the market.
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For example, our retained mortgage portfolio is about 9 percent of total mortgage debt outstanding. Our strong core capabilities position us to increase our share of this higher-margin business over time. A 9 percent share of a market that is growing at about 8 percent per year is a very attractive formula for continued attractive growth.
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On the credit business side, we also have an opportunity to increase our share using our core capabilities. We also call this our securitization business, in which we manage the credit risk on mortgages that we purchase. We have about 19 percent of this market in terms of mortgage debt outstanding - one trillion or so in our total mortgage portfolio vs. the 5.4 trillion or so of conforming mortgage debt outstanding. By bringing low-cost financing to new sectors, by being the lowest-cost way to finance mortgages and by using technology innovation, we expect healthy growth here as well.
In summary, as we look forward to the first decade of the 21st century, Freddie Mac is positioned to continue fulfilling our mission and building shareholder value.
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- Our financial and market positions are rock-solid.
- We enjoy a large market that is expected to grow 7 to 9 percent
per year.
- Our unique core capabilities will enable Freddie Mac to grow faster than the market.
In making your investment decisions, investors can continue to have confidence that the same characteristics of Freddie Mac in terms of safety, simplicity and transparency - which have defined Freddie Mac in the past - will continue to define us in the future.
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You can rest assured that we will continue to operate and be what we have been. We operate in a single, safe business by charter - residential mortgages backed by the equity of millions of American homes. Residential mortgage debt is among the least risky asset classes, and in Freddie Mac's business we disperse much of the risk to others.
We have a simple, clear corporate structure. Freddie Mac has no off-balance sheet subsidiaries or affiliates, and our financial statements are fully consolidated.
In addition, Freddie Mac is subject to continuous oversight by regulators and Congress. I like to say we operate in a fish bowl. On-site examiners, focused on safety and soundness, have a continuous presence at Freddie Mac. And unlike many financial institutions, our examination reports are made public on an annual basis in a report to Congress. Freddie Mac is also subject to stringent capital requirements that apply to all mortgages, all types of financial instruments and obligations.
Finally, Freddie Mac is a leader in providing timely, comprehensive and transparent financial disclosure. These disclosures are in the top tier of corporate America and exceed the recommendations, for example, of the Basel Committee on Banking Supervision for interest-rate and credit risk disclosure. This Committee sets disclosure standards for leading global financial institutions. Our disclosure provides complete information on our financial condition, our business activities, interest-rate risk, credit risk, corporate credit rating, liquidity status, capital strength, etc. They put us in the vanguard.
We are committed to maintaining the confidence of investors and to ensuring that you have the information to judge that we are disciplined and that we are responsible stewards of your capital. Freddie Mac has extraordinary opportunities in the years ahead. Few major financial services companies can match our record of translating opportunity into results.
I want to thank you for your interest in Freddie Mac. I want to thank the investors here for your commitment and confidence in us. We will continue to seek to earn that confidence.
Now, I would be pleased to answer any questions.
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| © 2008 Freddie Mac |
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