Welcome Back, Freddie Mac!

Last Thursday marked Freddie Mac's (NYSE: FRE  ) return to reporting quarterly earnings. During its five-year filing hiatus, the government-sponsored mortgage giant grappled with the ramifications of its 2003 accounting scandal, which prompted a $5 billion restatement of earnings.

At first blush, it seemed that the report's timely filing was the best thing about it. Freddie certainly didn't garner any immediate kudos, swinging from a year-ago $2 billion gain to a first-quarter $211 million net loss. Total revenue also fell 83% to $424 million, from $2.48 billion a year earlier. Expenses rose 84% to $1.07 billion, including a tripling of credit-related expenses, which totaled $193 million.

Mark-to-market losses on derivatives, which Freddie uses to hedge interest rate risk, accounted for much of these declines. Blame the weak housing market for that, creating wider credit spreads as the difference in yields between Treasuries and lesser-quality mortgage assets increased. Quality variances and the housing market's downturn also spurred an increased provision for credit losses.

Freddie acknowledged a higher foreclosure rate and higher loan loss severities, and it expects a rise in future charge-off levels. Still, the company's portfolio exhibited credit characteristics that exceeded historical averages, thus creating a similar trend in quarterly earnings.

Meanwhile, Freddie's core businesses grew, even as it operated under a voluntary growth limit. Management could afford to be opportunistic in the first quarter, since it had chosen not to increase its portfolio during the worsening credit quality environment of late 2006. The unpaid principal balance of its retained portfolio rose to $714 billion.

Instead of complaints about Freddie's bottom line, management deserves credit for weathering the housing downturn as well as it has, and for making prudent decisions. Freddie also intends to promptly file its 2007 annual report within 60 days of the end of the year. By doing so, the company can begin the registration process with the SEC in mid-2008.

While Freddie Mac embarks on its renewed path of reporting regularity, investors should note that filing obligations may be about the only certain thing they can expect. Freddie and sister Fannie Mae (NYSE: FNM  ) remain the focus of pending legislation aimed at strengthening lawmakers' oversight of the two firms. And even without any significant regulatory changes, volatility remains at the core of Freddie's business.

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Fool contributor S.J. Caplan does not own shares of the companies discussed in this article.


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