Refinancing And Affordable Housing Tailwinds Will Support Long Term Mortgage Securitization Stability

Catalysts

About Federal Home Loan Mortgage

Federal Home Loan Mortgage, commonly known as Freddie Mac, provides liquidity, stability and affordability to the U.S. housing finance system through single family and multifamily mortgage funding and securitization.

What are the underlying business or industry changes driving this perspective?

• The single family mortgage portfolio of US$3.7t and Freddie Mac's 51% GSE market share position the company to benefit if refinancing activity stays supported by periods of comparatively lower rates, which can support net interest income and fee driven revenues.
• The shift in multifamily toward fully guaranteed securitizations, with nearly all of the US$24b securitized in the quarter carrying guarantees and a higher average guarantee fee rate of 58 basis points, points to a business mix that can support net interest income and earnings quality.
• High credit quality in the single family book, with a weighted average current loan to value ratio of 53%, an average credit score of 753 and serious delinquencies at 60 basis points, together with broad use of credit enhancements, can help limit future credit losses and support net margins.
• Mission driven affordable housing exposure, including the majority of financed units affordable to households at or below 120% of area median income and 66% of multifamily new business labeled as mission driven affordable, aligns Freddie Mac with long run housing affordability initiatives that can support consistent loan volumes and revenue generation.
• The move to use VantageScore 4.0 from acquisition to securitization introduces a second credit scoring model that may widen access to qualified borrowers, potentially increasing addressable origination volumes and supporting long term growth in guarantee fees, net interest income and earnings.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Federal Home Loan Mortgage's revenue will grow by 1.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from -0.1% today to 0.0% in 3 years time.
• Analysts expect earnings to reach $0.0 thousand (and earnings per share of $0.0) by about May 2029, up from -$24.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of infx on those 2029 earnings, up from -953.0x today. This future PE is greater than the current PE for the US Diversified Financial industry at 17.1x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.46%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Refinance driven single family volumes rely on periods of comparatively lower mortgage rates, so a sustained period of higher or more volatile rates could reduce refinance demand. This could put pressure on new business activity, net interest income and fee based revenue.
• The current benefit from credit reserve releases is tied to assumptions for house price growth. If house prices flatten or fall versus these expectations, reserve builds could return and weigh on credit costs, net income and net margins.
• The company shows a regulatory capital shortfall, including a large amount of senior preferred stock that does not count as regulatory capital. Changes in capital requirements or slower capital build could limit balance sheet growth and affect future earnings capacity.
• The shift in multifamily toward fully guaranteed securitizations increases reliance on guarantee fee income while non interest income has already declined. Any compression in guarantee fees, weaker multifamily demand or higher multifamily credit losses could reduce segment revenue and overall earnings.
• Mission driven affordable housing exposure means the company is closely tied to long term housing affordability policies. Changes in regulation, support programs or credit standards could affect loan volumes, mix and pricing, which would flow through to revenue growth and return on equity.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of $14.7 for Federal Home Loan Mortgage based on their expectations of its future earnings growth, profit margins and other risk factors.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $24.0, and the most bearish reporting a price target of just $8.5.
• In order for you to agree with the analysts, you'd need to believe that by 2029, revenues will be $23.7 billion, earnings will come to $0.0 thousand, and it would be trading on a PE ratio of infx, assuming you use a discount rate of 12.5%.
• Given the current share price of $7.1, the analyst price target of $14.7 is 51.7% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.