Freddie Mac Says Earnings Fell Last Year But Remained Strong

Freddie Mac reported decent earnings for 2003 despite its accounting woes but it also warned that its efforts to return to regular and timely financial reporting will take longer than expected.

The giant mortgage company posted $4.9 billion in earnings for 2003, down 52% from 2002 when it reported record profits of $10.1 billion.

The publicly traded company blamed the huge drop primarily on the accounting standards for derivatives. The 2002 results were bolstered by a $5.3-billion gain in the value of its derivatives. In 2003, the derivative portfolio had a mere $39-million gain.

Derivatives also caused wide fluctuations in quarterly results - from a $2.5-billion profit in the second quarter of 2003 to a $288-million loss in the third quarter.

Last year's results were also crimped by $1.1 billion in investment losses, compared to a $1.8-billion gain in 2002. For comparison sake, Fannie Mae posted 2003 earnings of $7.9 billion.

"We produced another strong year of earnings," Freddie Mac chairman and chief executive Richard Syron told investors. "We enhanced our strong capital position. We managed our interest rate and credit risks to achieve truly impressive results."

However, he warned that it is going to take Freddie Mac longer to get its financial house in order.

The secondary market agency continues to play catch-up in its financial reporting due to a $5-billion accounting scandal and it will not be able to provide any 2004 quarterly financial reports until March 31, 2005.

The CEO said Freddie is "still far from finished" in rebuilding its accounting and control systems. He complained that the company relies on an "army of consultants" and manual systems to produce financial reports.

As a result, the government-sponsored enterprise will not begin regular quarterly reporting until the first quarter of 2005. However, company officials will conduct periodic briefings for investors to provide progress reports and answer questions.

Freddie Mac plans to release an audited 2003 annual report in September.

The release of the 2003 results on June 30 produced little reaction on the stock market. Freddie Mac's stock rose 11 cents on the day, even though some analysts increased their earnings projections and issued "buy" ratings on the stock.

The major credit rating agencies reaffirmed their ratings on Freddie Mac's debt and commented favorably on the progress the GSE is making in returning to timely financial reporting.

"While earnings volatility is a critical rating factor, Freddie Mac's underlying core mortgage business and interest rate risk management posture remains solid," Standard

& Poor's said.

FM Policy Focus noted that Freddie has a long way to go before it starts to file its financial reports with the Securities and Exchange Commission again.

"There is an urgent need for a new regulator with full power to determine what is really going on," FM Policy Focus executive director Mike House said.

Freddie Mac's CEO also called the current situation "unacceptable." He wants to see further progress so the Office of Federal Housing Enterprise Oversight will remove a 30% capital surcharge on the company. In January, OFHEO imposed the capital surcharge on the GSE "until its operational risk is reduced and timely, certified financial statements are produced."

Removal of the capital surcharge "will enable us to manage our capital account with shareholders in mind," he said. Mr. Syron became chairman and CEO in January.

Like he has done in other forums, the new CEO reiterated his intent to slow the growth rate of Freddie's retained mortgage portfolio during the conference call with investors.

He noted that the portfolio has grown from $60 billion to $600 billion over the past decade and that is unsustainable. "However, we will not hesitate to take advantage of profitable opportunities," he said. Freddie's retained mortgage portfolio grew by 14% in 2003 to $645.5 billion. So far this year, the portfolio has actually shrunk by 3.9%.

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