One step forward, one step back, and one silent shuffle made for a clumsy performance from mortgage finance company Freddie Mac (NYSE:FRE) when it reported annual earnings on Friday.
The positive step: a 4% increase in annual net profits to $2.2 billion. Despite a shaky housing market, Freddie Mac enjoyed a solid 10.6% growth rate in the loan guarantee business.
Uneven earnings were its backwards step, though. The company lost $480 million in the fourth quarter because of interest rate volatility, compared to a $684 million profit in the year-ago period.
The sideways shuffle remains Freddie's lack of progress in its financial reporting. The company has not reported on a quarterly basis since it became mired in an accounting scandal in 2003. Although the company disclosed a boost in spending to upgrade internal controls, it disappointed by failing once more to articulate a definitive timeline for its return to quarterly reporting. Besides detracting from investor confidence, this reporting absence has a quantifiable financial impact; Freddie must carry a 30% surplus capital level, which drags on growth and earnings. At the end of 2006, Freddie's core capital was estimated at $36.2 billion, including an estimated $2.6 billion in excess of the required amount.
As a footnote, the fallout from recent subprime mortgage deterioration has had "little or no" effect on Freddie. CEO Richard Syron acknowledged a slight credit deterioration in the company's overall holdings last year, and Freddie Mac recorded a $297 million loss reserve. Out of its $238 billion portfolio of mortgage-linked securities, ties to subprime loans accounted for $124 billion, all of which carried a AAA credit rating. Beginning in September, the company will stop purchasing loans it believes most vulnerable to foreclosure.
While the effect of the subprime market's losses may not have a large financial effect on Freddie or sister Fannie Mae (NYSE:FNM), the political repercussions might actually help their fortunes. Both Freddie and Fannie have recently testified before Congress that they may be needed to fill any void caused by a decrease in mortgage funding. Accordingly, both firms cautioned lawmakers not to order a reduction in their holdings.
Still, one never knows what regulators may do in the face of heightened public scrutiny. While Freddie also announced plans to repurchase an additional $1 billion in common shares, and issue as much as $1 billion in preferred stock, you may not want to choose Freddie as your dance partner just yet. Let the company first continue to clean up its own act, issue regular quarterly reports, and maintain its capacity to adequately manage risk. Then wait to decipher any regulatory changes before you engage in any investment tango.
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Fool contributor S.J. Caplan does not own shares of the companies mentioned.
