Philip R. Brinkerhoff, president of the Federal Home Loan Mortgage Corp. (Freddie Mac), says that, despite the dismal outlook nationwide for home finance and an 8 percent drop last year in his corporation earnings, FHLMC faces a "profitable future."
In 1981, when high interest rates began driving home buyers out of the marketplace, FHLMC--a central secondary mortgage bank for conventional home loans--posted a $30.9 million profit, down from $33.6 million the year before. At the same time, the Federal National Mortgage Association (Fannie Mae)--the other major, largely private secondary mortgage market firm--lost $190 million.
Why the sharp contrast in profit performance?
"We had a financial choice," Brinkerhoff said: "Whether to finance mortgage-buying operations by borrowing or by selling mortgage pass-through securities."
In 1975-77, he said, Freddie Mac decided on "pretty rigorously selling all the mortgages we bought," to raise the money to buy still more home loans. Congress chartered the corporation in 1970 to supply money raised in the nation's financial markets to savings and loan associations.
In an interview, Brinkerhoff noted that two former Federal Home Loan Bank Board chairmen, Preston Martin and Thomas Bomar--who served as FHLMC's first chairman and president--believed that borrowing short-term on the money markets to buy and hold long-term mortgages would be a dangerous strategy.
The transition to pass-through financing was given impetus when the prime rate jumped to "once-in-a-century heights" of 12 percent in 1973-74, said Brinkerhoff, who joined FHLMC as general counsel in 1973. "We thought if it could happen once, it could happen again," he said.
He said the corporation will adhere to current policy, because it provides "adequate profitability and less risk." He describes that policy as "conservative financial management" and "careful matching of assets and liabilities."
FHLMC will borrow to finance mortgage purchases, he said, only if it finds a security that matches the term, rate and prepayable features of home loans.
Brinkerhoff said he expects Freddie Mac to remain profitable, even if interest rates rise further.
He noted that the corporation's exposure to the credit markets is limited. It will expand borrowings by about $300 million in 1982, and roll over about $2 billion in debt. By comparison, Fannie Mae will borrow or roll over $1 billion to $3 billion every month this year.
Freddie Mac's largest asset is $5.2 billion of mortgages acquired in its first six years of operation (1971-77), an amount gradually paid down by homeowners. This is financed mainly by $5.1 billion in notes and bonds.
But $19.9 billion, or 79 percent of the $25.1 billion in mortgages from which the firm draws revenues, are owned by holders of participation certificates and other FHLMC pass-through securities.
On all these loans, Brinkerhoff said, the corporation earns a "locked in" spread every year until they are paid off.
In contrast to Freddie Mac's mid-1970s decision to ship mortgages out, Fannie Mae continued to ship money in.
At that time, Brinkerhoff said, Fannie Mae earned a larger spread, between mortgage rates and money market interest rates, than FHLMC made buying mortgages and selling certificates.
But in the process, Fannie Mae acquired a $60 billion portfolio made up largely of fixed-rate, low-yielding mortgages, and a $58 billion debt with an average maturity of two to three years. It also acquired a cushion of retained earnings, which Brinkerhoff said should see it through the current hard times.
He added, "Neither we nor they knew rates would rise this high." If rates fall enough to restore Fannie Mae to profitability, he said, time may prove its course to be the more lucrative.
"You have Fannie Mae, serving mainly mortgage banks, operated essentially as an S&L," he said, "while we, serving mainly S&Ls, work essentially as a mortgage bank."
Basic operating profits at FHLMC fell 59 percent in 1981, from $33.6 million in 1980 to $14.3 million. Brinkerhoff cites these factors as holding down profits:
* Corporate borrowing was expanded to start programs for buying adjustable-rate and home-improvement loans.
* The corporation's mortgage purchases were reduced, especially in the first half of 1981. The "swap" program, by which the corporation issues participation certificates to holders of old, low-yielding, fixed-rate mortgages, became regular only in October.
The "swaps" will add more to profits in 1982, Brinkerhoff said, because the corporation will earn a full year's interest-rate spread on billions of dollars of swapped loans. The firm also earns fees on the arrangement.
* High interest rates, which reduced the volume of mortgage lending, reduced the amount of new mortgages the corporation could buy.
"We are deeply anxious for rates to come down," Brinkerhoff said. "They [high rates] hurt our basic business."
Buoying 1981 profits were two accounting changes:
* Mortgage payoffs, mostly by homeowners selling their homes, now average 10 years, up from seven in the late 1970s. This delays FHLMC's final payoff to certificate holders, and is a profit item.
* The corporation curtailed payments to its reserve fund for uninsured home loan losses, because its losses were smaller than expected and less than the industry's average. Its reserves are now $80 million.
Freddie Mac's profits need not please Wall Street, because its only shareholders are the regional Federal Home Loan Banks. Its directors are the three presidentially appointed members of the Federal Home Loan Bank Board. The firm pays regular quarterly dividends totaling $2 million.
It now wants to sell shares to the public and to have a majority of its directors elected by the stockholders.
Brinkerhoff said that added capital "could triple the volume of money the corporation brings to housing." He said that in addition to mortgage insurance and the firm's reserves, buyers of FHLMC-guaranteed securities want to see more equity behind the corporation before they buy significantly more of the corporation's paper.
"We think we could sell equity in today's market," Brinkerhoff said, because of its prudent and profitable operations.
The plan to sell stock, dubbed the "Freddie Mac recapitalization," is before both houses of Congress and has the support of all the major housing, housing finance and banking trade groups except the National Association of Realtors.
Under the plan, Freddie Mac would surrender its tax-exempt status.
Of the three major secondary market institutions--FHLMC, Fannie Mae and the Government National Mortgage Association--only FHLMC faces no basic threat of cutbacks in operating authority or from severe earnings problems.
"All the major changes in housing finance favor our growth," said Brinkerhoff. He cited the proposed Ginnie Mae cutbacks, growth of conventional loans compared with FHA and VA loans, deregulation of financial institutions, interest rate violatility and the secondary market's growing importance in the retail home-loan business.
The firm is also increasing its effort to serve mortgage banks.
As Congress considers bail-outs and reforms of financial institutions, the Freddie Mac recapitalization is on the back burner. But, depending on the course of interest rates and the status of Ginnie Mae, Fannie Mae, FHA and the thrifts, the proposal may receive priority handling.