Bronte Capital’s John Hempton has gone on a Freddie Mac, Fannie Mae modelling extravaganza. And his conclusions are somewhat refreshing. Namely, he’s certain Freddie and Fannie are not the endless black hole of losses their topline numbers suggest them to be — or in the case of Freddie, the one-off accounting and mark-to-market benefits that recent profits were mostly put down to.
The reality is that the collapse in the market has turned the GSEs into a veritable monopoly in the market, bringing all the obvious advantages that come with that status. As Hempton explains:
Lack of competition means fat margins — and just as the revenue at Bank of America rose sharply during the crisis so does the revenue at the GSEs.
To prove his point he offers the following quarterly sequence of net interest income for Freddie Mac, adding that the numbers for Fannie are also similar:
He goes on:
The growth in these numbers is breathtaking. Operating costs are roughly flat. You would think they are rising because foreclosure and credit management (which costs Freddie money). However I suspect that those costs are offset by lower bonus payments to staff and similar costs. But with flat costs and revenue rising like this Fannie and Freddie are much more profitable on a pre-tax, pre-provision basis.
But while that increase in net interest income should be reassuring on a pre-provision basis, we remind readers a lot of it does come down to the plunging cost of short-term debt servicing for both agencies. Hempton himself, meanwhile, admits much of that pre-provision growth won’t be sustainable, as it resulted from gains on previously booked losses on derivative hedging instruments.
All that said, for the time being — at least in the case of Freddie — pre-provision profits could add up to at least $15bn a year as private sector competition in the mortgage market, notes Hempton, is unlikely to return rapidly. And as he says, $15bn per year can offset an awful lot of losses.
Related links:
Fannie Mae still bleeding money – FT Alphaville
Prime-time problems for Fannie – FT Alphaville