2Q07 earnings start with a whimper

With all the euphoria surrounding benign inflation figures (benign if you subscribe to the official numbers that exclude the necessities of life like food) some poor earnings figures slipped by without much notice.

Freddie Mac (FRE) recorded a $211m loss for 1Q07 citing losses on it's derivatives portfolio and widening credit spreads. That's right 1Q not 2nd, Freddie Mac was 80 days late in reporting and has been behind in it's quarterly reports since 2002 when they suddenly discovered that they had misstated earnings by a mere $5 billion or so.

For those that don't know Freddie Mac is a government sponsored enterprise that buys mortgages from banks, bundles them up and then sells them off, better know as securitization. Freddie Mac does not buy sub-prime loans however Freddie's Chairman and CEO Richard Syron noted that:

"the full impact of the housing downturn has not been felt."

Goldman Sachs (GS) topped analysts expectations with a whopping 1% increase in 2Q07 earnings. CFO David Viniar said in a conference call that the subprime sector's woes are not over and to expect "more pain" before the problem is purged.

Bear Stearns (BSC) posted a 33% profit decline for 2Q07 noting:

"Mortgage-related revenues reflected both industry-wide declines in residential mortgage origination and securitization volumes and challenging market conditions in the sub-prime and Alt-A mortgage sectors."

Another point of interest has been the revelation that a hedge fund run by BSC, called the High-Grade Structured Credit Strategies Enhanced Leverage Fund, is scrambling to sell about $4 billion in mortgage-backed bonds to raise cash to meet investor redemptions and to prepare for possible margin calls. The fund has slumped 23% this year to April and is highly leveraged with roughly $6 billion in assets.

The good news for BSC is that they only have a small amount of their own capital in the fund. It was only a matter of time until something like this happened given the state of the US mortgage market and I suspect it won't be the last we here about.

To be fair it hasn't all been gloom on the earnings front with Lehman Brothers (LEH) posting a 27% increase in 2Q07 earnings earlier in the week. However LEH is obviously feeling the pinch of the housing downturn after deciding to rationalize their residential mortgage businesses by cutting 400 jobs.