By James Tyson
Jan. 5 (Bloomberg) -- Freddie Mac, the second-largest source of money for U.S. home loans, reported a $550 million net loss for the third quarter and had an undetermined loss in the fourth quarter as lower bond yields reduced investment returns.
The loss compares with net income of $880 million in the year-ago third quarter, the McLean, Virginia-based company said in a statement today. The results, which don't include per-share figures, are preliminary estimates as the government-chartered company continues a three-year overhaul of its accounting.
Freddie Mac, which owns or guarantees about 20 percent of the $10.5 trillion U.S. residential mortgage market, hasn't released timely financial reports since revealing in 2003 that it understated net income by $5 billion to minimize earnings volatility. The irregular earnings and a federal limit on the company's mortgage portfolio have discouraged investors.
``It's hard for us to buy stocks without solid financials,'' said Michael Mullaney, who manages $10 billion at Fiduciary Trust Co. in Boston, including 76,000 Freddie Mac shares. ``The delay in the reporting really hurts us from a fiduciary standpoint.''
Freddie Mac shares fell $1.02, or 1.5 percent, to $66.91 in New York Stock Exchange composite trading. The percentage drop is the biggest for the stock since Nov. 9.
The company won't provide results for the first quarter of 2007 until the second half of the year, Freddie Mac President and Chief Operating Officer Eugene McQuade said in an interview.
``Sometime in the second half of this year, we expect we would be able to get back to quarterly reporting,'' McQuade said. ``This is exactly what investors are anticipating.'' The company intends to provide 2006 results by the end of March.
Asset Losses
Fannie Mae, the larger rival to Freddie Mac, said last month it overstated earnings for 2001 through mid-2004 by $6.3 billion. The Washington-based company, which plans to file 2005 financial results by the end of September, hasn't said when it will restore timely reporting.
Both companies profit by guaranteeing mortgage securities and by holding home loans and mortgage securities in their portfolios. As interest rates fall, homeowners increasingly pre- pay their mortgages or refinance their loans, disrupting income from the companies' guarantee business.
Freddie Mac's third-quarter performance stemmed from $1.5 billion in pretax losses on derivatives and other assets and obligations, the company said.
The fair value of net assets attributable to shareholders failed to grow from the end of the second quarter because of the interest rate declines and a reduction in the difference between the company's borrowing costs and the yield on its investments, Freddie Mac said.
Reflection of Volatility
The results ``reflect the volatility we see quarter-to- quarter in response to movements in interest rates,'' Freddie Mac Chief Executive Richard Syron said in the statement. ``We face a challenging market environment.''
Freddie Mac's estimated net income for the first nine months of last year was $2.5 billion compared with $1.4 billion in the same period of 2005. The projected loss for the fourth- quarter of 2006 compares with net income of $684 million in the year-earlier period.
Derivatives are financial instruments derived from stocks, bonds, loans, currencies and other assets, or linked to specific events like changes in the weather or interest rates. Freddie Mac typically never realizes gains or losses from derivatives because it holds the instruments to maturity.
Accounting Costs
Freddie Mac spent $1.2 billion in the first nine months of last year fixing accounting and other administrative expenses, compared with $1.1 billion during the same period of 2005.
Fees related to personnel and the use of new technology primarily drove the increase in expenses, McQuade said. Such costs should stabilize ``in the next couple of years.''
The company plans by mid-2007 to finish installing new accounting systems for its mortgage portfolio and the management of its debt and derivatives, Chief Financial Officer Anthony Piszel told analysts on a conference call today.
``When they get installed, it dramatically reduces the overall risk environment that we operate in,'' he said. ``This is a little later than we initially planned.''
Freddie Mac also has reduced employee turnover to 8.5 percent in recent months compared with about 15 percent the previous year, McQuade said.
Mortgage Portfolio
Freddie Mac's portfolio of loans, which generates about two-thirds of profit, fell at a 0.2 percent annual rate in November to $704.3 billion. The assets declined at an annual rate of 0.9 percent from January until November. The portfolio rose 8.7 percent in 2005.
The Office of Federal Housing Enterprise Oversight in July required Freddie Mac to constrain quarterly growth of its mortgage portfolio to 0.5 percent beyond the June 30 level of $722.2 billion pending completion of improvements in accounting and corporate governance. Freddie Mac also must hold 30 percent more reserve capital than normal to ensure safety and soundness.
``Operational, accounting and systems weaknesses remain'' at Freddie Mac, Ofheo said in a Dec. 28 statement. ``Significant work remains before Freddie Mac becomes a timely financial filer and corrects the evident operational weaknesses.''
To contact the reporter on this story: James Tyson in Washington at at jtyson@bloomberg.net
Last Updated: January 5, 2007 16:16 EST
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