Freddie Mac Profit Tumbles on Bad Hedges

NEWYou can now listen to Fox News articles!

Freddie Mac (FRE), the second-largest U.S. home financing company that is pushing to emerge from a scandal-marked era, on Thursday posted a more than 40 percent drop in 2004 net income as the value of contracts used to hedge against interest rate changes fell.

Freddie earned $2.8 billion, or $3.78 per diluted share, in 2004, compared with $4.8 billion, or $6.68 per share, in 2003.

The mortgage funder blamed the steep drop in net income on losses related to derivatives. But Freddie said that while its derivatives can lead to big earnings swings, the instruments remain important in managing interest rate risk.

"Overall it does look good," said Ed Groshans, analyst at Fox-Pitt, Kelton in New York.

"I know people aren't going to be excited about the bottom line," Groshans said. But he said that 2005 results will likely be less impacted by hedging activities. "So we'll get a cleaner number."

Analysts on average pegged Freddie Mac's 2004 net earnings at $6.87 per share, according to Reuters Estimates.

Most analysts use an estimate that excludes various items, ranging from $6.00 to $8.68 per share for 2004, but the company said it is trying to get back to regular financial reporting and has not yet developed such a figure.

The McLean, Va-based company has not been current in its financial reporting since a 2003 accounting scandal led to a $5 billion restatement. Freddie is due to start posting quarterly results on a regular basis again later this year.

Freddie, a shareholder-owned company chartered by Congress to boost homeownership by ensuring a liquid mortgage market (search), said the fair value of its net assets at the end of 2004 was $30.8 billion, up 13 percent from 2003.

Credit losses rose slightly but remained low compared with historical standards, according to the company. Freddie also said it was in compliance with its regulatory capital requirements throughout the year, and ended 2004 with $3.5 billion in capital over the regulatory target.

Freddie and its sister government-sponsored housing enterprise, Fannie Mae (FNM), do not lend directly to home buyers. Instead, they buy mortgages from lenders and repackage them as securities for sale to investors. They also hold some mortgages in their own portfolios.

The companies together account for nearly half of total residential mortgage debt outstanding, according to their regulator.

Freddie and Fannie, however, face the possibility of tougher U.S. supervision over their operations. Congress is due to weigh legislation that could give their regulator more power over the companies, including authority to approve any new products or programs they want to launch.

Freddie said legislative reforms on the table could hurt the its financial condition in future years, and stop the company from both fulfilling its federal mission to support home ownership and providing returns to shareholders, Freddie Mac said.

Specifically, earnings could be hurt if Congress limits the companies' portfolio activities -- a real possibility after Federal Reserve Chairman Alan Greenspan (search) urged lawmakers last month to slash Freddie's and Fannie's mortgage holdings.

"Legislative or regulatory limitations on our ability to conduct these activities, through restrictions on portfolio size, debt issuance or otherwise, could require us to significantly alter our current business activities and could adversely affect our future profitability," Freddie Mac said.