Freddie Mac Stuns Investors With Bigger Loss

Freddie Mac, the No. 2 U.S. mortgage finance company, stunned Wall Street with a unexpectedly wide loss and plans to slash its dividend or use other means to raise capital to withstand a continuing downturn in the housing market.

Freddie Mac shares lost more than one-quarter of their value after reporting a net loss of $2 billion, blaming falling home prices and tighter credit conditions for having increased the number of borrowers defaulting on their mortgages. It was the worst one-day percentage drop ever and pummeled the stock to an 11-year low.

A foreclosed home for sale.
David J. Phillip
A foreclosed home for sale.

While the report was a blow to shareholders, it was also bad news for homeowners who need Freddie Mac's lending resources, which have funded millions of mortgages under a congressional mandate since 1970. The company's dwindling capital will crimp its ability to play its role fostering home ownership in a market already hit by lender pullbacks.

In a briefing, Chief Executive Office Richard Syron offered little hope for a quick recovery and instead emphasized a need for fast action to bolster its finances.

"Given the continuation of the same market trends that produced these results through October and November, it is likely that the fourth quarter will prove difficult as well," he said in a conference call to investors.

Freddie Mac said it has hired Goldman Sachs and Lehman Brothers to help it raise capital in the "very near term" as its soaring losses force it to build reserves that will satisfy its regulator.

Preferred Stock Sale

The company said it is considering a preferred stock sale to boost reserves. CNBC reported that this might be done in concert with the other main government sponsored enterprise,
known as a GSE, Fannie Mae to offer the securities.

Other alternatives could include cutting back on lending or cutting the dividend. Freddie Mac has never trimmed its dividend since going public in 1989, but the company said Tuesday that it may cut its fourth quarter payout 50 percent.

"I suspect it will continue to worsen in terms of actual defaults," said Charles Lieberman, chief investment officer of Advisors Capital Management LLC in Paramus, New Jersey, which
owns Freddie shares.

The housing market has been gripped by uncertainty since homes going into foreclosure surged to record levels at the end of last year, mostly in the risky subprime sector. Freddie Mac's loans are largely made up of higher quality debt and its problems show a continuing widening out of the nation's housing debt problem.

The dismal report dragged shares of larger rival Fannie Mae down about 20 percent. Countrywide Financial , the largest U.S. mortgage lender, also was under pressure as it stock fell sharply, though it denied Wall Street rumors that it was suffering liquidity problems.

Hitting Bottom Line

Buddy Piszel, Freddie Mac's chief financial officer, said the housing market will hurt the company's bottom line for some time even though the company mostly deals in low-risk home
loans offered to strong borrowers.

"Certainly, when housing markets deteriorate, that has an impact. We clearly will incur higher costs with markets being what they are," said Piszel.

The $2 billion loss, or $3.29 a share, compared with a loss of $715 million, or $1.17 a share, in the year-ago period. Wall Street analysts, on average, had expected Freddie Mac to report
a third quarter loss of $2.16 per share.

The increase in the number of its loans heading into foreclosure has forced the company to increase its provisions for failing loans. It added $1.2 billion for credit losses and increased fees for guaranteeing the payment on home loans.

Freddie Mac also said the value of its net assets decreased by about $8.1 billion in the third quarter as investors have shunned mortgage assets. The fair value is the price that an
investor would willingly pay for an asset and the worth of Freddie's mortgage holdings have sunk along with value of home loans generally.

The cost to insure Freddie's bonds against default rose to a record 65 basis points after its earnings, according to data from Markit which dates from 2004. Freddie Mac and Fannie Mae
are chartered by Congress and investors treat them as if they have an implied government guarantee.

Cushion Against Losses

Piszel said that fresh capital would be used to maintain a cushion against losses. Freddie also wants the capital to leave it with some flexibility to increase its mortgage investment holdings, he said.

"Given where credit is heading, given how we performed in 2007, we believe that we need to raise capital," Piszel said.

Fitch Ratings, however, said it may cut Freddie's AA-preferred stock rating following news it was looking at raising additional capital.

Partly to increase its capital ratio, Freddie sharply shrank its holdings of mortgage securities in October and pushed them further below a growth limit set by the regulator, the Office of Federal Housing Enterprise Oversight.

Freddie Mac's retained mortgage portfolio dropped by an annualized 16.9 percent rate in October to $703.1 billion, after decreasing significantly the previous month.

Freddie shares hit an 11-year low while Fannie Mae shares reached a 12-year trough in early trading. Freddie shares are down 58 percent year-to-date, compared with a 48 percent drop
in the KBW Mortgage Finance Index over the same period.