In 2003, Freddie Mac has been at the centre of a long running accounting saga, lost three of its board members and has had to start much of its investor relations effort from scratch. However, as Seb Boyd discovers, the agency's treasurer Louise Herrle has plenty of fight left in her.
This has been an awful year for Freddie Mac. The US government sponsored enterprise has been hit by a series of revelations about its accounting practices, and on June 9 lost its CEO, chief financial officer and chief corporate controller.
The problems stem from attempts by Freddie Mac employees to smooth earnings by using derivatives transactions to delay the reporting of income. In January, Freddie Mac announced that its auditor PricewaterhouseCoopers was concerned about the way that previous auditor Arthur Andersen had accounted for certain derivatives transactions, and that it would be unable to sign off on the company's accounts.
It later transpired that the company's senior management had been aware of and even designed the transactions, but had lacked the accounting expertise to condemn them.
The company is now working flat out to restate those earnings, which, according to spokesman Mike Robinson, should be done by the end of September.
The spectre of the accounting scandal has dogged the agency from the very beginning of year. "One of the big successes we had was the January euro," says Freddie Mac's treasurer, Louise Herrle. "There was good outright investor demand for Freddie Mac at that time, and the securities were performing well. We had a lot of demand - we were seeing improved demand for Freddie Mac in the primary market at that time. And right in the middle of bookbuilding, we announced the earnings restatement.
"At one point in the process there was quite a sense of disappointment because we had to interrupt the transaction and we were worried about losing momentum. We had to re-evaluate and we decided to go ahead. The decision was vindicated since we ended up increasing the size of the bond to Eu4bn, demonstrating that investors appreciated the chance to digest the new information."
The next week, EuroWeek reported that the Eu4bn deal, led by BNP Paribas, Merril Lynch and UBS, had been hailed by bankers as the agency's best in that currency yet.
"Less than 5% of the orders dropped out, and that was because they were forced to invest earlier," Paul Richards, head of the public sector and debt transactions groups at Merrill Lynch, said at the time.
"Since January it has been a challenging year on the funding side," Herrle says. "We have had to take into consideration what has been going on at Freddie Mac, in Congress and in the market.
"From January to June our bonds were trading very well, however, we have lost some ground since June 9. In dollars the cost is approximately 2bp, in euro the deterioration versus our peer group has been greater. We have had an outreach programme to investors over the last few years and we have done a lot of work getting to know investors, probably more in Europe in recent years, and that has mitigated some of the cost."
Freddie Mac's regulator, the Office for Federal Housing Entreprise Oversight (OFHEO), had been previously viewed by many market participants as ineffective and hidebound but has discovered fresh zeal since the White House in February announced that its Clinton-appointed director Armando Falcon would be replaced.
In August it decided that Freddie Mac would have to replace its new CEO Greg Parseghian, the former head of funding and investment who is widely admired by the market. According to a report by lawyers hired by Freddie's board, Parseghian had been involved in the controversial derivatives transactions.
Fitch then downgraded Freddie Mac's subordinated debt - supposed to reflect what its financial strength would be if it were not a GSE - from AA to AA-.
Freddie Mac has $700bn of debt unaffected by the downgrade and $10bn that is affected, Robinson said.
"[The Fitch downgrade of our subordinated debt] did not seem to have a lot of impact on the market," Herrle says. "Standard & Poor's and Moody's held their ratings and by the end of the day there was little impact."
Freddie's first priority this year has been and remains getting the restatement of earnings out to investors. The agency has lost some credibility with investors, and is going to have to work to regain that. The restatement of earnings must be the first step.
"Our feedback is that these investors who want to see the restatement completed will begin buying Freddie Mac once this barrier is removed," says Herrle.
In the past there has been a tendency for some investors to look upon Freddie's government sponsored enterprise status as a guarantee, at least implied, of government support. This year, investors are being forced to pay more attention to the fundamentals of Freddie Mac and of Freddie Mac's business, as well as examining the differences in the business model of Freddie Mac and Fannie Mae - two ostensibly similar companies, which in fact manage their risk in very different ways.
"This is an opportunity for us to meet investors," Herrle says. "Although this has been a challenging year there is one positive thing to have come out of it. Investors' time is very valuable, but they do want to meet with us and find out what we are doing from a funding standpoint. That then is an opportunity for them to get to know our business better.
"On the debt funding side we have a very good track record and we have to demonstrate that we are serious about what we do, which is to provide value for investors and proving a good investment experience."
Euro market still key
On September 5 Freddie announced the four banks to arrange its Eu3.5bn benchmark - ABN Amro, Credit Suisse First Boston, Dresdner Kleinwort Wasserstein and Morgan Stanley.
The rising rates environment should have little effect on its finding needs. But Freddie Mac measures its own pricing performance based on its debt spread to mortgages, so continued widening of Freddie's spreads could in theory effect portfolio growth.
The recent rapid rise in Treasury yields hurt investors, and the volatility naturally stifled primary issuance over the summer. "There is more pressure to right-size our issuance since market demand has demonstrated volatility," Herrle says.
However, a rising market will not affect total funding volumes, and Herrle does not believe that it will alter the most interest rate sensitive debt product that Freddie issues.
"We will always have an underlying demand for callable funding," she says. "The callable product is critical to our risk management strategy, and the issuance of callables allows us to use less derivatives product."