Industry News

Freddie Mac Announces Record Operating Earnings For Second Quarter 2002

July 23, 2002

Second Quarter 2002 Operating Earnings Per Share Up 26 Percent

McLean, VA - Freddie Mac (NYSE:FRE) today announced operating earnings for second quarter 2002 were $968 million, compared to $769 million for the same period a year ago and $893 million for first quarter 2002. Diluted operating earnings per common share were $1.30 for second quarter 2002, compared to $1.03 for second quarter 2001 and $1.19 for first quarter 2002.

Freddie Mac's operating earnings and diluted operating earnings per common share exclude certain accounting effects related to SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," as amended. Management believes that results presented on an operating basis are beneficial in understanding and analyzing Freddie Mac's financial performance because they better reflect the economic effect of the corporation's risk management activities. As reported under generally accepted accounting principles ("GAAP"), net income for second quarter 2002 was $1.110 billion, an increase of 21 percent from second quarter 2001 net income of $914 million. Diluted earnings per common share for second quarter 2002 were $1.50, an increase of 21 percent from second quarter 2001 diluted earnings per common share of $1.24. First quarter 2002 net income and diluted earnings per common share were $1.413 billion and $1.94, respectively.

"Freddie Mac continued to deliver strong financial results in the second quarter, and we remain on track for record results in 2002," said Leland C. Brendsel, Chairman and Chief Executive Officer. "We also took other steps to demonstrate our leadership in financial disclosure, voluntarily initiating SEC oversight of our disclosures and becoming among the first major financial services companies to recognize the expense of employee stock options."

"Our second quarter results are characterized by low levels of interest-rate and credit risk, negative growth in the retained portfolio and the build-up of capital from retained earnings," added David W. Glenn, Vice Chairman and President. "These results reflect our conservative risk management principles and our discipline of investing in the retained portfolio only when returns are attractive. If tight mortgage-to-debt spreads persist, making it difficult to find retained portfolio opportunities that meet our return thresholds, we will increasingly utilize share repurchases as an alternative to building capital."

Highlights for second quarter 2002:

• Freddie Mac'sretained portfolio contracted by $7 billion during the second quarter, representing annualized growth of negative 5 percent. This decline reflects the corporation's commitment to its investment discipline of deploying capital only when long-term economic returns are attractive and when it can prudently manage risk.
• Freddie Mac's fully taxable equivalent (FTE)operating net interest yield was 88 basis points in the second quarter, down 1 basis point from first quarter 2002.
• Freddie Mac'sportfolio market value sensitivity remained a low 2.74 percent in the second quarter, unchanged from first quarter 2002. This reflects the corporation's continued prudent interest-rate risk management.
• Freddie Mac's second quartercredit losses represented 0.8 basis points of its average mortgage portfolio, unchanged from first quarter 2002. The corporation's credit losses remained low despite higher real estate owned ("REO") activity due to its strong credit position and the sustained strength of the housing market.
• Freddie Mac has concluded that its continuing strong credit innovations and experience have contributed to aloan loss reserve which has been $250 million in excess of that required by GAAP, and as a result will reduce its reserves by this amount. As discussed later in this press release, the adjustment to reduce Freddie Mac's loan loss reserve balance will increase net income and retained earnings. Such adjustments are not reflected in the financial statements and tables that accompany this press release.
• Freddie Mac's administrative expenses were $204 million in second quarter 2002, down $24 million from first quarter 2002. Further demonstrating its commitment to financial transparency, Freddie Mac's administrative expenses now include the effect of expensingstock options. This expense was less than $4 million in the second quarter, representing less than $0.01 per diluted common share.
• Freddie Mac's safety and soundness regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), announced that as of March 31, 2002, the corporation's total capital exceeded the requirement of therisk-based capitalstandard by $15.7 billion. This assessment reflects Freddie Mac's low risk profile and the conservative manner in which it operates.

Total Portfolio Growth

Freddie Mac's total mortgage portfolio grew at a 14 percent annualized rate from $1.203 trillion at March 31, 2002 to $1.244 trillion at June 30, 2002. This growth was driven by new business purchase volume (which excludes purchases of Freddie Mac PCs for the retained portfolio) of $115 billion in second quarter 2002, down from $126 billion for second quarter 2001 and first quarter 2002's record volume of $151 billion. Also affecting total mortgage portfolio growth were liquidations of $74 billion in second quarter 2002, compared to $72 billion in second quarter 2001 and $86 billion in first quarter 2002.

Operating Revenues

Freddie Mac's operating revenues reached $1.614 billion in second quarter 2002, a 22 percent increase over $1.325 billion for second quarter 2001, and up from $1.547 billion for first quarter 2002. Operating revenues include operating net interest income and operating other, net (both defined below), but exclude SFAS 133-related changes in derivative market values, which are reported on Freddie Mac's Income Statement as "Hedging (losses) gains." Reported revenues for second quarter 2002 were $1.833 billion, compared to $1.547 billion for second quarter 2001 and $2.346 billion for first quarter 2002.

Portfolio Investment Business

Retained Portfolio Growth

The retained portfolio declined at a 5 percent annualized rate, decreasing from $526 billion at March 31, 2002 to $519 billion at June 30, 2002. The contraction in the retained portfolio during the second quarter reflects Freddie Mac's adherence to its investment discipline. The corporation will invest in mortgage assets only when returns meet its thresholds and related risks can be effectively managed. During second quarter 2002, the returns available on mortgage investments generally were not attractive.

Operating Net Interest Income

Operating net interest income reflects adjustments to reported net interest income to exclude certain accounting effects associated with SFAS 133. These adjustments include the recognition of straight-line amortization expense on purchased option premiums and the reversal of certain SFAS 133 mark-to-market adjustments.

Freddie Mac's operating net interest income totaled $1.292 billion in second quarter 2002, compared to $904 million in second quarter 2001 and $1.294 billion for first quarter 2002. Reported net interest income for second quarter 2002 was $1.560 billion, compared to $1.190 billion in second quarter 2001 and $1.723 billion in first quarter 2002.

FTE operating net interest yield on earning assets was 88 basis points in second quarter 2002, compared to 77 basis points in second quarter 2001 and 89 basis points in first quarter 2002.

Portfolio Market Value Sensitivity

Freddie Mac continued to be well-protected against interest-rate changes. The corporation's primary indicator of interest-rate risk-portfolio market value sensitivity (PMVS)-remained at low levels. PMVS averaged 2.74 percent in second quarter 2002, down from 3.12 percent for second quarter 2001 and unchanged from first quarter 2002. Freddie Mac estimates that a PMVS of approximately 3 percent corresponds to a duration gap of less than one month.

Securitization Business

PC Portfolio Growth

The Total PC portfolio grew at a 16 percent annualized rate from $1.012 trillion at March 31, 2002 to $1.053 trillion at June 30, 2002. The Total PC, net portfolio (which excludes Freddie Mac PCs held in the retained portfolio) grew at a 28 percent annualized rate from $677 billion at March 31, 2002 to $725 billion at June 30, 2002. Growth in Freddie Mac's PC portfolios reflects strong mortgage originations, driven by historically low mortgage rates and a robust home purchase market.

Guarantee Fees

Management and guarantee income totaled $478 million in second quarter 2002, compared to $398 million for second quarter 2001 and $453 million for first quarter 2002. During second quarter 2002, the average balance of Total PCs increased by $55 billion, or 6 percent, from first quarter 2002, while the average guarantee fee rate was 18.5 basis points, compared to 18.8 basis points for the same quarter a year ago and unchanged from first quarter 2002.

Credit

Freddie Mac demonstrated excellent credit performance during the second quarter, driven by effective risk management and favorable economic conditions. The corporation's credit results continue to reflect the benefits of its automated underwriting and loss mitigation activities, high levels of credit enhancement, and consistently strong, nationwide house-price appreciation. Specific indicators of Freddie Mac's strong credit performance are discussed in the paragraphs that follow.

The corporation's single-family, at-risk delinquency rate-an indicator of potential future credit losses-was 0.36 percent for May 2002, unchanged from June 2001 and down from 0.39 percent in March 2002. In each of the five geographic regions, Freddie Mac's single-family delinquencies declined relative to first quarter 2002.

The net carrying value of delinquent multifamily loans was $6 million at the end of May 2002, compared to $4 million at June 30, 2001 and $43 million at March 31, 2002. As a percentage of the unpaid principal balance of multifamily mortgages serviced, the multifamily delinquency rate was 0.02 percent at the end of May 2002, unchanged from June 30, 2001 and down from 0.14 percent at March 31, 2002.

At June 30, 2002, total REO balances were $505 million, compared to $363 million at June 30, 2001 and $484 million at March 31, 2002. Single-family REO balances were $504 million at June 30, 2002, compared to $360 million at June 30, 2001 and $483 million at March 31, 2002. Multifamily REO balances were $1 million at June 30, 2002, compared to $3 million at June 30, 2001 and $1 million at March 31, 2002.

Despite higher REO activity during second quarter 2002, Freddie Mac's credit losses remained flat. Annualized second quarter 2002 credit losses (charge-offs plus REO operations expense) were 0.8 basis points of the average total mortgage portfolio (excluding non-Freddie Mac mortgage securities), compared to 0.6 basis points in second quarter 2001 and 0.8 basis points in first quarter 2002.

In second quarter 2002, mortgage charge-offs were $26 million, compared to $22 million in second quarter 2001 and $24 million in first quarter 2002. Second quarter 2002 single-family charge-offs were $26 million, compared to $24 million for second quarter 2001 and $25 million for first quarter 2002.

Credit-related activities for second quarter 2002 resulted in income of $4 million, compared to expenses of $18 million for second quarter 2001 and $24 million for first quarter 2002. The provision for mortgage losses was zero for second quarter 2002, compared to $26 million for second quarter 2001 and $28 million for first quarter 2002.

Loan Loss Reserves

Freddie Mac's philosophy is to manage credit risk conservatively and to be cautious about forecasting future financial trends. Freddie Mac maintains loan loss reserves to absorb credit losses on the corporation's existing portfolio. Under GAAP, loan loss reserves take into account a number of factors, including portfolio characteristics, default and loss experience and expectations, and economic conditions. Uncertainty and judgment are inherent aspects of the reserving process. Freddie Mac's strong focus on credit has contributed to fundamental improvements in its understanding and management of credit and to a continuous improvement in credit quality. Over the past few years, advances in automated underwriting and loss mitigation strategies, an increased use of credit enhancements, and strong house price appreciation have resulted in substantial decreases in credit losses. During this period of favorable credit performance, Freddie Mac's loan loss reserves remained relatively stable.

Freddie Mac recently conducted a review of its loan loss reserves in consultation with its new independent auditors. Based on this review, management concluded that its loan loss reserve balance has been approximately $250 million more than the level required by GAAP. As a result, Freddie Mac will reduce its loan loss reserve balance by $250 million pre-tax. This reserve reduction relates primarily to periods prior to 1999 and may require restatement of the results for those periods. The adjustment will result in an increase in net income and retained earnings of approximately $160 million after-tax. Such adjustment is not reflected in the financial statements and tables that accompany this press release.

Freddie Mac will be reviewing the accounting for this adjustment with the SEC in the near future. Freddie Mac will announce the accounting treatment by the end of the third quarter of 2002.

Other Corporate Results

Operating Other, Net

Operating other, net, reflects adjustments to reported Other, net, to exclude certain accounting effects associated with SFAS 133. These adjustments represent the difference in gain/loss recognition on sales of options or hedged assets and on repurchases of hedged debt between SFAS 133 and operating earnings. Operating other, net, was a loss of $156 million in second quarter 2002, compared to income of $23 million for second quarter 2001 and a loss of $200 million for first quarter 2002. Reported other, net, for second quarter 2002 was a loss of $90 million, compared to income of $23 million for the same period a year ago and a loss of $70 million for first quarter 2002.

In second quarter 2002, Freddie Mac early adopted SFAS 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections," which eliminates extraordinary treatment of the gains/losses on debt repurchases for Freddie Mac. As a result of the adoption of SFAS 145, gains/losses on debt repurchases are now included in "Operating Other, Net" and reported "Other, Net." For comparative purposes, prior period data have been reclassified to reflect this revised reporting.

During second quarter 2002, Freddie Mac repurchased $7.3 billion of long-term debt and incurred operating losses of $0.23 per diluted common share, compared to $1.1 billion of debt repurchased in second quarter 2001 and operating losses of $0.05 per diluted common share. During first quarter 2002, the corporation repurchased $3.3 billion of long-term debt and incurred operating losses of $0.25 per diluted common share.

Administrative Expenses

Second quarter 2002 administrative expenses totaled $204 million, compared to $194 million for second quarter 2001 and $228 million for first quarter 2002. Annualized administrative expenses represented 6.7 basis points of the average total mortgage portfolio in second quarter 2002, compared to 7.6 basis points in second quarter 2001 and 7.8 basis points in first quarter 2002. As discussed below in the "Accounting for Stock Options" section of this press release, beginning in second quarter 2002, Freddie Mac's administrative expenses include the effect of expensing stock options. In the second quarter this expense was less than $4 million.

Accounting for Stock Options

Freddie Mac historically applied APB Opinion No. 25, "Accounting for Stock Issued to Employees," for its stock options, which in most circumstances does not require the recognition of compensation expense. In second quarter 2002, Freddie Mac voluntarily adopted the fair value method of accounting for its stock option grants under the guidance of SFAS 123, "Accounting for Stock-Based Compensation." Although SFAS 123 permits companies to either recognize compensation cost currently in income or alternatively disclose the pro-forma impact, management believes expense recognition is the preferred method of accounting. Therefore, pursuant to the requirements of SFAS 123, all options granted subsequent to December 31, 2001 will be recognized as compensation expense.

For the six months ended June 30, 2002, administrative expenses include the effect of expensing stock options, which totaled less than $4 million. The impact on first quarter 2002 is immaterial as option fair value is amortized over the expected life of the option. Therefore, the impact of Freddie Mac's annual employee options awarded in March 2002 equates to three months of amortization in second quarter 2002 as opposed to one month of amortization in first quarter 2002. The full year 2002 pre-tax impact is estimated to be between $10 million and $15 million.

Capital

The corporation's total capital (regulatory core capital plus the reserve for mortgage losses) was $22.225 billion at June 30, 2002, compared to $17.661 billion at June 30, 2001 and $21.363 billion at March 31, 2002.

Freddie Mac repurchased 515,000 shares or $32 million of common stock in second quarter 2002. The corporation did not repurchase common stock in second quarter 2001 or first quarter 2002.

In second quarter 2002, Freddie Mac did not issue any preferred stock. The corporation issued $374 million of preferred stock during second quarter 2001 and $300 million during first quarter 2002. Freddie Mac redeemed $287 million of preferred stock during first quarter 2002.

During June 2002, OFHEO announced that Freddie Mac's total capital exceeded the first application of the risk-based capital standard by $15.7 billion as of March 31, 2002. Freddie Mac's surplus against the risk-based standard reflects its low level of interest-rate and credit risk and favorable market conditions.

Freddie Mac's minimum capital surplus, the excess of Freddie Mac's core capital over the minimum capital requirement, was estimated at approximately $2.0 billion at June 30, 2002, compared to $0.6 billion and $1.2 billion at June 30, 2001 and March 31, 2002, respectively.

Business Outlook

Freddie Mac continues to expect operating earnings growth of 16 to 18 percent in 2002.

Given year-to-date portfolio growth and the currently tight mortgage-to-debt spreads, the corporation now anticipates 2002 retained portfolio growth will be in the 8 to 12 percent range. In addition, Freddie Mac continues to expect its average operating net interest yield for 2002 to be somewhat above 2001's average of 80 basis points.

Freddie Mac continues to expect credit losses to increase over the balance of the year. Finally, Freddie Mac anticipates low double-digit growth of administrative expenses in 2002.

Conference Call

Freddie Mac will host a conference call discussing the corporation's second quarter 2002 results today at 4 p.m. eastern time. The conference call will be Web cast live on Freddie Mac's Web site.

A telephone recording of this conference call will be available continuously beginning at 7:30 p.m. eastern time Tuesday, July 23, 2002 until midnight Tuesday, August 6, 2002. To access this recording, call 1-800-475-6701 and use access code 643965.

Freddie Mac's quarterly announcements of earnings results sometimes contain forward-looking statements pertaining to management's current expectations as to Freddie Mac's future business plans, results of operations and/or financial condition (see "Business Outlook" section). Management's expectations for the corporation's future necessarily involve a number of assumptions and estimates, and various factors could cause actual results to differ materially from these expectations. These assumptions and factors are discussed in the corporation's Annual Report to Shareholders and its Information Statement and quarterly Information Statement Supplements.

Freddie Mac is a stockholder-owned corporation established by Congress in support of homeownership and rental housing. Freddie Mac purchases single-family and multifamily residential mortgages and mortgage-related securities, which it finances primarily by issuing mortgage passthrough securities and debt instruments in the capital markets. Over the years, Freddie Mac has opened doors for one in six homebuyers in America.

Freddie Mac's earnings releases and other financial disclosures are available on theShareholders' page.

Full Earnings Release [pdf]

Source: Freddie Mac

Contact ALTA at 202-296-3671 or [email protected].