UPDATE 3-Freddie Mac profit jumps; will pay U.S. Treasury $4.4 bln

Wed Aug 7, 2013 12:28pm EDT

* $5 bln profit is second largest in company's history

* Derivatives gain of $1.4 bln due to rising rates

* Still weighing when to book massive gain on deferred tax assets

By Margaret Chadbourn

WASHINGTON, Aug 7 (Reuters) - Freddie Mac, the U.S.-owned mortgage finance company, on Wednesday said its second-quarter profit surged 65 percent to $5.0 billion, its second largest ever, as rising home prices limited credit losses and it booked big gains on derivatives that benefited from rising interest rates.

That big profit and another like it expected soon from larger sister Fannie Mae are fast becoming the centerpiece of the debate over housing-finance reform, which has languished since taxpayers stepped in to rescue the pair to the tune of nearly $188 billion during the financial crisis.

The fact that Freddie and Fannie have turned from taxpayer-financed money pits to cash cows for the federal budget is certain to complicate reform efforts just gaining momentum in Washington. The president weighed in on the issue on Tuesday, calling for a smaller government role in the mortgage market.

Freddie Mac, which has operated under federal conservatorship since it was seized in 2008 during the financial crisis, said that based on its net worth of $7.4 billion, it will make a dividend payment of $4.4 billion to the U.S. Treasury as part of the reimbursement for its rescue aid.

Meanwhile, the company continued to hold off on writing up $28.6 billion in tax assets, an accounting move that would dramatically increase its remittance to the Treasury. A determination on when to mark up some or all of the so-called deferred tax assets could occur by year end, the company said.

"If the positive trend in our book and taxable income continues, we may release the valuation allowance in the next two quarters," Freddie Mac Chief Executive Officer Donald Layton said in a conference call.

Fannie Mae has already booked a comparable allowance in the first quarter, triggering a massive dividend to the Treasury of $59.4 billion, most of which was attributable directly to the accounting gain.

For the second quarter, Freddie's net income rose to $5.0 billion from $3.0 billion a year earlier. It was up 9 percent from the first quarter's $4.6 billion, putting the company on track for record annual profitability.

Lifting the results were a $1.4 billion gain on interest- rate swaps that profited from the rise in interest rates during the quarter. The yield on the benchmark 10-year U.S. Treasury note, to which mortgage rates are tied, rose 1.05 percentage points in the second quarter on fears that the U.S. Federal Reserve may soon scale back its massive stimulus program, called quantitative easing.

The Fed is buying $85 billion a month in Treasuries and mortgage-backed securities backed by Freddie and Fannie, a program that had driven interest rates on mortgage loans to record lows earlier this year.

The Mortgage Bankers Association on Wednesday reported the average rate for a 30-year fixed-rate mortgage rose to 4.61 percent in the latest week, from 4.58 percent the week before. Rates were below 3.6 percent in early May and had been below 3.5 percent back in December.

PROFITS FROM HOUSING RECOVERY

The return to profitability of Freddie and Fannie in the last two years has largely occurred on the back of a continuing housing market recovery, marked by rising home prices and falling mortgage delinquencies.

U.S. home prices are rising at the fastest pace since 2006. The S&P/Case Shiller index of property values in May showed home prices racked up a hefty 12.2 percent gain from the year before.

Both Freddie Mac and Fannie Mae are required to pay everything above $3 billion to the Treasury in return for taxpayer aid under existing bailout terms.

The two companies have paid nearly $132 billion in dividend payments. Freddie expects to pay the Treasury the $4.4 billion dividend payment by September, bringing Freddie's total to roughly $41 billion as the amount of dividends it will have paid to the Treasury. The company has drawn $71 billion in federal aid, which leaves taxpayers on the hook for about $30 billion.

The debate over how to restructure Fannie Mae and Freddie Mac, along with the broader mortgage market, has kicked off in Congress. President Barack Obama said on Tuesday he wants a smaller federal role in the housing finance system. Any new structure is expected to take years, as lawmakers dismantle and replace the companies.

"There's no question in my mind that the big profits that both Fannie and Freddie are generating are in some sense affecting the debate," said Lewis Alexander, chief U.S. economist at Nomura Securities in New York.

"I think everybody in the mortgage business kind of understands that the current state of affairs is not credible in the long run, and to some extent, the profits that Fannie and Freddie are producing are evidence of that."

Both companies have said they expect to remain profitable. The reversal of fortune has led speculators to bet that the companies might repay their debt to taxpayers and exit government control. Investors, led by a handful of hedge funds, have recently poured into both the common and preferred stock of Fannie Mae and Freddie Mac in the hope that the companies will eventually be able to buy their way out of government control.

Fannie Mae, which has yet to report its second-quarter results, made a large payment to the Treasury after concluding that it needed to reverse write-downs of tax assets that led to billions of dollars in losses when they were written down.

Fannie posted a net income of $58.7 billion in the first quarter, mainly due to the one-time gain of $50.6 billion related to the tax assets. The company also reported a pre-tax income of $8.1 billion for the quarter, compared with a $2.7 billion profit in the same three months a year earlier.