Freddie Mac, the ailing GSE so weak the Feds took the reigns back in September, is reporting the first quarterly profit in almost two years. And not surprisingly all the financial networks, blogs, and newspapers are running the headline touting Freddie Mac’s return to profitability. On the surface this would be good news, but one only has to look a little deeper to change their mind.

Freddie Mac’s press release states:

“Net income for the second quarter of 2009 was $768 million. After the dividend payment of $1.1 billion to the U.S. Department of the Treasury on the senior preferred stock, net loss per diluted common share was $0.11 for the quarter. “

Wait a minute…they lose 11 cents a share for the quarter and the press will report a profit?

Saying you’re posting a “profit” for the quarter if it wasn’t for a some of our obligations like $1.1 Billion in dividends is like saying “I’m alive now…just ignore the grapefruit sized hole in my chest caused by a point-blank discharge of a 12-gauge shotgun.”

I’ll concede compared to the $3.14 net loss per share in the first quarter of 2009 only losing 11 cents per share is a dramatic improvement. However, a loss is still a loss. Everyone should report it that way…no spin…no hyperbole.

This common sense adage is even more germane when you look at the tough-to-replicate way Freddie Mac posted their supposed profit.

To quote the press release again:

“The second quarter 2009 results were primarily driven by:

  • Net interest income of $4.3 billion;
  • Gains on the company’s derivative portfolio and guarantee asset of $4.2 billion, mainly related to net mark-to-market gains due to increases in long-term interest rates;
  • Net impairment of available-for-sale securities recognized in earnings of $2.2 billion, also reflecting the adoption of FSP FAS 115-2 and FAS 124-2; and
  • Provision for credit losses of $5.2 billion.”
  • Let’s break this down…

    First, interest rate derivative trades show a profit when rates rise. Freddie Mac hedges long term interest rates to make money on the trade when rates rise. However this gain is offset by honoring previously locked loans at lower rates earlier in the quarter. Most of the time is the trade is a “wash”. Only some times is it a gain. It is never a gain when lost loan demaind is considered.

    When considering lost loan demain, this hedge trade can be understood by using “opportunity cost” metaphor. The opportunity cost of the hedge trade profit is the loss in new loans the company does not get when rates climb. In other words, the company would much rather have the profit from the 1,000′s of loans they didn’t get due rising rates than the hedge trade income.

    Second, the “provision for credit losses of $5.2 billion” is a one-time credit and is more accounting hocus pocus than reality.

    So as long as you think a person can walk around with a hole in their chest than it’s okay for you to consider Freddie Mac “alive and well” too.

    But if you are like me…saddled with a need for reality in financial reporting…do NOT need dubious profitability reports.

    Are they healing?


    Are they profitable?

    Not in any meaningful or replicatable way…not by a long shot.

    The interim CEO, John Koskinen, said it best himself:

    “…we recognize that our financial results for the quarter include one-time accounting adjustments and mark-to-market gains that are subject to change in future periods”

    So why does Wall Street and the company want to spin this report to sound so rosy?

    Good question…here’s the answer.

    When this report came out on Friday, they knew a Freddie Mac 3-month bill auction would go off today. They wanted alot of investors to show up and bid on their debt.

    And quess what? It worked!

    Reuters reported the sale of $2 billion in bills had higher rates and a stronger demand than last week’s auction.

    Be careful about where you get your mortgage news. Of course, you already knew that or you would be reading this.

    Good Luck!

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