is trimming back some hedges.
The McLean, Va., company is changing how it accounts for some derivatives contracts in a move that parallels what regulators are demanding of sibling
. The company also said the growth of its mortgage portfolio has slowed dramatically.
Freddie, the nation's second-largest mortgage buyer, announced the move in a press release after the market closed Monday. The company disclosed the decision, which affects its booking of derivatives contracts, as it updated its progress in reporting 2004 financial results.
Freddie said Monday it intends to report its 2004 full-year earnings next March and to resume filing regular quarterly reports by the middle of next year. Freddie had stopped reporting earnings in a timely fashion last year, following an accounting scandal that resulted in a $5 billion restatement and the payment of a $125 million fine.
On Monday, Freddie didn't provide any estimate of the financial impact of its decision to discontinue "hedge accounting" for some fixed-interest rates swaps, a type of derivatives contract.
The accounting treatment for derivatives is complex and depends on whether derivatives are used as part of a hedging strategy, or for speculative investment purposes.
The move by Freddie to reclassify some of its derivatives could have ramifications for Fannie, which is facing many of the same accounting questions that Freddie wrestled with last year. As with Freddie, most of the problems with Fannie's books focus on accounting for derivatives.
Derivatives are sophisticated financial instruments that the companies rely on to hedge their exposure to interest rate fluctuations, which can wreak havoc on the value of their mortgage-related investments. While there's nothing inherently wrong with using derivatives as a hedging strategy, critics contend derivatives can be abused by managers looking to delay the recognition of gains and losses in order to manage earnings.
In September, the Office of Federal Housing Enterprise Oversight, the regulator for both Fannie and Freddie, issued a highly critical report on Fannie's accounting practices. The regulator accused Fannie of using improper methods to value its many derivatives transactions and engaging in earnings management. Specifically, regulators contend Fannie used a so-called cookie jar reserve, built on the delayed recognition of profits, to smooth its reported quarterly earnings.
Fannie executives are standing by their accounting practices. The company is trying to convince the
Securities and Exchange Commission
, which has launched its own investigation, of the soundness of its accounting methods.
Monday's news came as Freddie said the rate of growth in its mortgage portfolio
slowed over the first nine months of 2004, reflecting competition from other buyers and less attractive interest spreads.
Freddie said in a preliminary update Monday that its total mortgage portfolio stood at $1.49 trillion at Sept. 30, compared with $1.41 trillion at Dec. 31, 2003. Its mortgage purchase volume was $383.8 billion in the first nine months of 2004, compared with $668.5 billion last year.
Freddie's retained mortgage portfolio rose by 3.1% from a year ago to $660.7 billion at Sept. 30, 2004.
The company makes money by purchasing mortgage loans from banks, collecting the income or repackaging them as bonds. The portfolio growth Freddie did manage in 2004 reflected a relatively lower rate of mortgage liquidations and the purchase of adjustable-rate mortgage bonds backed by subprime or home equity mortgage loans.
"Mortgage-related investment opportunities in fixed-rate products have not been as attractive to us because strong demand from other investors, coupled with lower mortgage loan originations, have generally resulted in unattractive mortgage-to-debt option-adjusted spreads," Freddie said.
On Monday, Fannie rose 27 cents to $70.42 and Freddie rose a dime to $66.70.