Real Estate Lender Implosion

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Freddie Mac’s Big Loss Dims Hopes of Turnaround

By CHARLES DUHIGG
Published: August 6, 2008

The gloom over the nation’s housing market deepened on Wednesday as Freddie Mac, the big mortgage finance company, reported a gaping quarterly loss and predicted that home prices would fall further than previously projected.

The announcement disappointed those hoping that the housing market might be bottoming out and heightened worries that the government could be forced to rescue Freddie Mac and the other mortgage finance giant, Fannie Mae. The news also signaled that mortgage rates were likely to rise.

In filings with the Securities and Exchange Commission, Freddie Mac said that “there is a significant possibility that continued adverse developments” could cause the company to fall below government-mandated capital levels. In an interview, the company’s chief financial officer, Anthony S. Piszel, said that warning did not imply the company believed that risk was likely or imminent.

Freddie Mac and Fannie Mae, which lubricate the housing market by buying mortgages from banks and other lenders and touch nearly half of all the nation’s home loans, have been severely weakened by the slump in the housing market. The downturn has forced millions of Americans out of their homes, cost Wall Street hundreds of billions of dollars and helped depress the broader economy.

“Basically, things are still bad,” said Steven D. Persky, chief executive at Dalton Investments, a $1 billion fund in Los Angeles. “Freddie Mac is telling us that nobody really knows how much worse they will get.”

The results disappointed analysts who had hoped Freddie Mac might provide enough good news to point a way out of the economic darkness. The company’s results contained few rays of light.

Freddie Mac announced $2.8 billion in credit expenses associated with increased housing delinquencies and foreclosure rates, and said that the value of mortgage-backed securities it holds had declined by $1 billion. The company lost $821 million during April, May and June, compared with a profit of $729 million during the comparable period a year earlier.

“Home prices declined faster than anticipated in the first half of 2008,” Richard F. Syron, Freddie Mac’s chairman and chief executive, said during a conference call with analysts. Executives believe the housing market is only about halfway through its downward cycle, he said.

“At this point neither we nor anyone else can predict when the national housing market will stop falling,” Mr. Syron said.

Executives said they expect the firm’s losses would increase through at least 2009, and that home prices would continue to decline by as much as an additional 9 percent.

Freddie Mac’s stock price fell by 19 percent on Wednesday, to close at $6.49.

Executives said they would shore up Freddie Mac’s capital reserves by cutting the firm’s quarterly dividend by 80 percent to 5 cents per share, pending board approval. The company also reiterated its commitment to raising at least $5.5 billion from investors.

However, as the company’s stock price has declined, raising those funds has become increasingly expensive. The company’s entire worth as measured by the stock market was $4.2 billion as of Wednesday afternoon.

“How do you raise $5 billion when the market thinks your entire company is only worth $4 billion?” asked Sean Egan, managing director of Egan-Jones Ratings, an independent credit ratings firm. “Investors need to believe good news is around the corner to give a company more money, and Freddie Mac has said there is more bad news to come. We don’t think they’re going to be able to raise it.”

In an interview, Mr. Piszel said he believes the company is currently undervalued and that the current market capitalization will not undermine the firm’s ability to raise money.

If Freddie Mac is unable to raise capital, it could spark a political and financial crisis. Last month, Treasury Secretary Henry M. Paulson Jr. proposed giving federal officials the ability to pump billions of dollars into Freddie Mac and Fannie Mae by buying shares in the companies. That plan became law in a bill signed by President Bush last week.

Mr. Paulson has said he hopes to never use those powers. At the end of June, Freddie Mac held $2.7 billion more than what regulators require.

But if Freddie Mac continues to suffer losses and is unable to raise funds from investors, the company could fall below capital requirements, potentially forcing the government to pour in funds or take control of the firm.

In the call with analysts, executives said their confidence in the ability to raise capital stemmed from a variety of factors, including improving profit margins and accounting rules that would allow them eventually to reverse some of their current losses.

“We believe we can manage to maintain our capital position for some time,” said Mr. Piszel in the interview. In Wednesday’s earnings release, the company offered extensive data showing how its capital levels would fare under various scenarios.

“We’re not going to rush to raise capital because we don’t have to,” said Mr. Piszel. “We have disclosed the range of pain we can take, and we think it demonstrates the company is positioning itself to withstand severe stress.”

Analysts said the quarterly results indicate that mortgage rates would most likely continue to rise because Freddie Mac expects to scale back growth in how many mortgages it purchases.

“Freddie and Fannie have been propping up the mortgage market by continuing to buy larger numbers of loans,” said Paul Miller of the Friedman, Billings, Ramsey Group, an investment firm in Arlington, Va. “If they start pulling back, mortgage rates are going to start climbing to north of 6.5 percent. People will start panicking at 7 percent.”

The average interest rate on a 30-year fixed mortgage as of July was about 6.5 percent, according to Freddie Mac.

The company’s results on Wednesday also contained some small bits of good news.

Freddie Mac said revenue grew by more than 10 percent from last quarter, to $1.69 billion, including a 92 percent increase in net interest income to $1.5 billion. And executives indicated that profit margins on the loans they were now buying were at much higher levels than in previous years.

“They are the only game in town right now, and if Freddie and Fannie can make it out of this they’ll be enormously profitable down the road,” said David Dreman of DWS Dreman Concentrated Value, a $16 billion investment fund that owns about 10 million shares of Freddie Mac.

“Now the big question is, what will they look like when they make it through this crisis, and how bad will it get until it’s over?” Mr. Dreman added


http://www.nytimes.com/2008/08/07/business/07freddie.html?em