Freddie Mac reports 52% net income decrease in '03

Freddie Mac, a stockholder-owned company established by Congress in 1970 to support homeownership and rental housing, reported its 2003 financial results June 30.

According to a Freddie Mac news release, the report highlighted several findings about the company's performance in 2003:

Freddie Mac financed homes for approximately 6 million families, including 2.5 million low- and moderate-income families, 184,000 first-time home buyers and 720,000 minority families;

Freddie Mac's net income was $4.9 billion, representing a 52 percent decrease compared to $10.1 billion in 2002;

net interest income was down slightly at $9.498 billion, compared to $9.525 billion in 2002;

noninterest income was negative $259 million, compared to $7.1 billion in 2002;

noninterest expense was $2.1 billion, compared to $1.9 billion in 2002;

diluted earnings per common share were $6.79, down 52 percent compared to $14.18 per share in 2002;

total stockholders' equity increased by $232 million, or 0.7 percent;

fair value of net assets (net of tax effect) grew by $4.5 billion, or 20 percent;

net credit losses remained low, averaging 0.7 basis points of the average total mortgage portfolio;

total mortgage portfolio grew by $97.8 billion, or 7 percent, to $1.4 trillion; and

retained portfolio grew by $78.2 billion, or 14 percent, to $645.5 billion.

Summary factors

The 52 percent decrease in net income was primarily driven by a substantial decrease in total noninterest income. Noninterest income results continue to be affected by changes in unrealized gains and losses on certain financial instruments that the company reports at fair value. Changes in the level and volatility of interest rates have resulted in significant period-to-period volatility in reported net income. To the extent changes in interest rates continue to be significant, Freddie Mac's overall net income will remain volatile. For net interest income, 2003 results were attributable to the positive effects of a decrease in average debt funding costs and growth in the retained portfolio, largely offset by lower yields on assets acquired in 2003 and increased amortization expense related to premiums paid on interest earning assets.

Net interest yield decreased to 127 basis points in 2003 from 146 basis points in 2002. The decline in net interest yield was driven by increased amortization expense related to premiums paid on interest earning assets and by the addition of lower-yielding mortgage-related securities in 2003, which outpaced the benefit of improved funding costs and lower derivative-related expenses during 2003. During the first quarter of 2003, the company refined the assumptions and calculations for the amortization of deferred fees recorded as discounts on assets in its retained portfolio, most notably with regard to estimates of future prepayments.

Management and guarantee income, which is a component of "Noninterest income (loss)" on the consolidated statements of income, was $1.6 billion in 2003, compared to $1.5 billion in 2002. Reported management and guarantee income consists of the guarantee fee on outstanding mortgage-backed securities guaranteed by Freddie Mac, referred to as Participation Certificates, or PCs, and the amortization of certain fees paid by the seller/servicer at the time of securitization that are amortized into management and guarantee income over the estimated life of the security. The increase in reported management and guarantee income in 2003 was driven by a 3 percent increase in the average balance of outstanding PCs and an increase in net amortization income related to the fees paid to Freddie Mac.

Noninterest expense totaled $2.1 billion in 2003, compared to $1.9 billion in 2002. During 2003, Freddie Mac incurred significant increases in "other expenses" primarily due to accounting, auditing and consulting costs of approximately $124 million and legal costs of approximately $48 million associated with the restatement and related remediation activities, the $125 million civil money penalty discussed below and fees of $124 million that were paid in connection with certain multifamily affordable housing transactions. The 2002 results include a $225 million charge related to a special cash contribution to our philanthropic program, which includes the Freddie Mac Foundation and corporate giving programs. The company did not make a similar contribution in 2003.

As discussed in its Information Statement dated Feb. 27, Freddie Mac is subject to various legal proceedings. In December 2003, Freddie Mac entered into a consent order with the Office of Federal Housing Enterprise Oversight, or OFHEO, Freddie Mac's safety-and-soundness regulator. Under the terms of the consent order, Freddie Mac paid a $125 million civil money penalty and Freddie Mac is undertaking a variety of remedial actions in accordance with a prescribed schedule. No provisions have been made in Freddie Mac's financial results with respect to other governmental investigations or civil litigation because, at present, it is not possible to accurately predict the outcome of the various legal proceedings or regulatory investigations or reasonably estimate the amount of loss (or range of possible loss) that might result from adverse resolutions of any of these matters, or their potential effect on the company's financial condition and results of operations.

"These results demonstrate Freddie Mac's continued robust financial performance and underscore the strength of our underlying business," said Richard F. Syron, Freddie Mac's chairman and CEO. "Last year, Freddie Mac capitalized on market opportunities while maintaining strict adherence to the financial and risk management disciplines that are a core strength of our company. Given the challenges the company faced in 2003, this strong financial performance is particularly noteworthy. It is important to point out, however, that 2003 was a unique year, with the ongoing remediation of our financial reporting processes, a volatile market and strong mortgage origination activity that may not be replicated in the near future. As a consequence, certain exceptional results such as fair value net asset growth exceed our long-run expectations."

Syron added that the company is focused on its mission to make home financing more affordable.

"The completion of our 2003 financial results in accordance with our announced timetable is another important step for Freddie Mac on our path to returning to timely reporting," said Martin F. Baumann, executive vice president finance and chief financial officer. "We are making substantial progress overhauling Freddie Mac's financial reporting and accounting systems, but this process is a challenging one and more hard work is in front of us. As part of this effort, we are devoting the full scope of our corporate resources to rebuilding our processes and systems to return to timely reporting as quickly as possible."

According to the release, Freddie Mac expects to publish its 2003 annual report in late September, and to hold the related stockholders' meeting in November 2004. The current objective is for the company to provide quarterly and full-year financial results for 2004 by March 31, 2005.