Can of Worms

According to Freddie’s restated financial earnings, the $5 billion cumulative net income increase resulted from earnings increases of $4.3 billion in 2002, $1.1 billion in 2000 and $0.6 billion in periods before the year 2000. The restated total was close to what Freddie officials had previously estimated. But, until Friday, Freddie had only said it underreported earnings in three years’ worth of financial statements, and the restatement showed Freddie inflated its earnings by $1 billion in 2001. This was attributed primarily to unrealized losses on derivatives not in hedge accounting relationships.

The restatement was overdue since it was reported in June that Freddie had manipulated its earnings to avoid appearing volatile. The accounting errors led to the replacement of three top executives.

But, while the restatement reflected more accurate earnings results, it also highlighted new problems.

“Restated net income reflects significantly greater volatility than previously reported,” said Freddie, adding that it expects “its net income for periods following the restatement will continue to reflect greater volatility than previously reported from quarter to quarter. For example, during 2001 and 2002, quarterly net income ranged from a low of a loss of $111 million in the first quarter of 2001 to a high of a gain of $5.7 billion in the third quarter of 2002.”

Freddie added that “as a result of the restatement, a large majority of the company’s derivative portfolio is not eligible for hedge accounting treatment,” primarily due to inaccurate valuations and inadequate documentation of hedges.

Regulatory core capital, which Freddie says equals Stockholders’ equity excluding Accumulated Other Comprehensive Income, increased to $5.2 billion, $0.8 billion and $1.9 billion in 2002, 2001 and 2000, respectively, according to the report.

Restated Stockholders’ Equity reflected increases to $6.7 billion, $4.3 billion and $2.5 billion for the same three years. Meanwhile, net interest income, which the mortgage giant says is its principal source of earnings, increased to $8.9 billion, $7.0 billion and $3.8 billion.

The company said its objective is to release quarterly and yearly 2003 results by the end of June 2004. Soon after, Freddie plans to provide its 2003 annual report and its related stockholders’ meeting. Although Freddie does not have to file with the Securities and Exchange Commission, it plans to do so when it returns to timely reporting.

Adding to Freddie’s troubles, was the participation of CEO Greg Parseghian in the restatement call. According to the Wall Street Journal, the Office of Federal Housing Enterprise Oversight — Freddie’s regulator which is also known as OFHEO — was told the executive would not take part in it. The act can result in a cease-and-desist order of the CEO, who was involved in the accounting scandal and was allowed to remain in his position until a successor was found, said WSJ.

Furthermore, the McLean, Va. company is still subject to various investigations.

“The necessity of this restatement and the magnitude of the accounting improprieties and management misconduct reinforce the need for remediation and enforcement actions by OFHEO,” said the regulator’s director Armando Falcon Jr. in a statement Friday. “The circumstances that gave rise to this restatement are the subject of our ongoing investigation and will be fully addressed in our forthcoming report.”

In June, Freddie disclosed that the U.S. Attorney’s Office in Alexandria, Va., opened a criminal investigation involving the mortgage firm. In part of its restatement, Freddie said the Attorney has interviewed certain Freddie employees and other parties, and has taken testimony before the grand jury. No specifics were given about the testimony.

Other investigations such as those by the SEC, the Internal Revenue Service and the Department of Labor, were again mentioned in the restatement.