Derivatives Accounting Hurts Freddie Mac Earnings

Freddie Mac reported yesterday that its profit plummeted by 60 percent during the first half of this year, to $1.6 billion from $4.1 billion in the comparable period last year.

"Our balance sheet is in great shape," Chief Financial Officer Martin F. Baumann said yesterday during a conference call with analysts.

Baumann said the $2.5 billion drop in profit was partly due to a decline in interest income. But he said it was also the result of Freddie Mac's stricter use of generally accepted accounting principals, or GAAP, which forces the company to book temporary and often wide swings in the value of its derivatives on its income statement, without respect to how its core business is performing. Derivatives are complex financial instruments used to protect against changing interest rates, and are integral to Freddie Mac's mortgage business.

Because of the way the principles treat derivatives, "GAAP doesn't really translate our business very well," Baumann said in an interview.

Freddie Mac officials already offer additional numbers, calculated using what they call a "fair value" methodology. By that measure, the company is still not doing as well as it was last year. The fair value grew $1.1 billion during the first half of 2005, compared to $2.5 billion for the same period a year earlier. The decline was partly due to losses on derivatives.

But the company's share of the secondary mortgage market grew to 45 percent for the first six months of 2005, up from 41 percent for the same period in 2004. The company yesterday said it was projecting that a main driver of profits, the retained portfolio, which contains mostly mortgages and mortgage-backed securities, would grow about 5 percent for the year. As of June 30, 2005, the retained portfolio stood at $673.9 billion, up from $664.5 billion at the end of 2004.

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