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Federal Home Loan Mortgage Corporation (FMCC) reported third-quarter 2013 net income of $30.5 billion, well ahead of the prior-quarter earnings of $5 billion. A benefit for federal income taxes of $23.9 billion related to valuation allowance against net deferred tax assets in the reported quarter drove the increase in income.

Freddie Mac reported pre-tax income of $6.5 billion, up 32.7% sequentially, reflecting the 8th consecutive quarter of positive earnings and the second highest earnings in the company’s history.

Performance in Detail

Net interest income rose 3.2% sequentially to $4.3 billion. Net interest yield stood at 0.86%, up 3 basis points sequentially. The surge reflects lower funding costs, partially offset by reduced yielding earning assets. Further, non-interest income more than doubled from the prior quarter to $1.7 billion.

Non-interest expense surged 15.9% from the prior quarter to $577 million. The rise in expense reflects reduced real estate owned (REO) operations income driven by lower REO outflows.

Freddie Mac reported benefit for credit losses of $1.1 billion in the quarter, compared with $623 million in the prior quarter. The increase was driven by $0.9 billion of recoveries from counterparty settlements along with persistent improvement in national home prices.

Furthermore, segment-wise, on a sequential basis, Investments, Single-family Guarantee and Multifamily segments recorded 12.1%, 53.8% and 100% rise in earnings, respectively.

Based on net worth of $33.4 billion, Freddie Mac’s dividend obligation to Treasury will stand at $30.4 billion in Dec 2013. Notably, including this dividend obligation, the company’s aggregate cash dividends paid to Treasury will sum to $71.345 billion as compared with cumulative cash draws of $71.336 billion received from Treasury.

Further, since Jan 1, 2009, Freddie Mac provided $2.1 trillion of liquidity to the mortgage market, which helped in funding 7.5 million refinancings, 1.9 million home purchases and 1.5 million units of multifamily rental housing. Moreover, the company helped about 913,000 borrowers to avoid foreclosure.

Recent Settlements

During the reported quarter, Freddie Mac entered into deals with Wells Fargo Bank, N.A., a subsidiary of Wells Fargo & Company (WFC - Analyst Report), certain affiliates of Citigroup Inc. (C - Analyst Report), and SunTrust Mortgage, Inc. to discharge precise loans from certain repurchase obligations in lieu of one-time cash payments. Notably, these agreements increased the company’s pre-tax income by $0.9 billion in the third quarter.

Additionally, in Oct 2013, Freddie Mac entered into settlements with JPMorgan Chase & Co. (JPM - Analyst Report) under which the company will be paid about $3.2 billion in the fourth quarter.

Our Viewpoint

We believe Freddie Mac’s improving top-line performance and recent settlements will yield profitability in the coming quarters. Moreover, enhancement in the credit quality is another positive. However, increase in non-interest expenses remains a concern. Currently, Freddie Mac carries a Zacks Rank #2 (Buy).

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