By David S. Hilzenrath
Washington Post Staff Writer
Thursday, May 15, 2008
Rising loan delinquencies and falling home prices took an increasing toll on Freddie Mac during the first quarter, but accounting changes obscured the blow.
The giant mortgage funding company, a bellwether of market conditions, reported that it lost $151 million (66 cents per share) in the three-month period ended March 31, compared with a loss of $133 million (35 cents) in the first quarter of 2007.
However, those bottom-line numbers did not reflect the mounting cost of actual and anticipated losses from defaults, foreclosures and the like, known as credit-related expenses.
Freddie Mac reported $1.45 billion of credit-related expenses in the first quarter, up more than half from the previous quarter and more than fivefold from the first three months of last year.
If the company were forced to liquidate its holdings at current prices, it would have been left with a loss, based on a snapshot Freddie Mac provided of its assets and liabilities. The estimated asset value swung to negative $5.2 billion on March 31 from positive $12.6 billion on Dec. 31.
The hole could have been deeper: If not for changes in valuation methods, the March estimate would have sunk by $4.6 billion more.
"[I]t's clear we have not yet hit bottom in the housing market," Richard F. Syron, Freddie Mac's chairman and chief executive, said in a briefing for analysts.
Chartered by the government to keep mortgage money flowing, Freddie Mac packages mortgages into securities for sale to investors, promising to cover the loan payments if the borrowers default. It also buys mortgages. Those functions help lenders get mortgages off their books, freeing funds to make more loans.
When the housing market was booming, many government officials were worried that Freddie Mac and its rival, Fannie Mae, were growing so large that they posed a risk to the financial system, potentially leaving taxpayers on the hook for a federal bailout. Now, the government is counting on the companies to support the market and is allowing them to operate with thinner financial cushions.
Both companies are required to maintain minimum levels of capital as protection against losses. The government raised the requirement after accounting scandals at the two firms but lately has been scaling back the amount as the companies put those troubles behind them.
Freddie Mac said yesterday that it planned to raise $5.5 billion of capital in the near future by selling more common and preferred stock. Issuing more common stock dilutes the value of current investors' shares, and issuing preferred stock saddles the company with additional costs.
The added capital will help Freddie Mac meet the housing market's needs while putting the company on a stronger footing, Chief Financial Officer Anthony S. "Buddy" Piszel said in a news release.
Holding onto the capital would give Freddie Mac a bigger safety margin. Alternatively, using the capital would enable Freddie Mac to buy or guarantee more mortgages but could leave it more exposed to a further downturn.
Freddie Mac fell below its required capital level late last year before raising $6 billion from investors.
The McLean company promised in March to raise more capital as part of a deal with its regulator, the Office of Federal Housing Enterprise Oversight. That deal allowed Freddie Mac and Fannie Mae to operate with smaller cushions. Freddie Mac has not fulfilled that pledge; Fannie Mae recently raised $5.05 billion through stock offerings.
Freddie Mac's plan to raise $5.5 billion apparently would count toward the March promise and earn the company another cut in its capital requirement.
Freddie Mac said the regulator plans to reduce its capital requirement a second time when the company completes the coming stock offerings and a third time when it fulfills other long-standing commitments, such as separating the roles of chairman and chief executive.
The financial report that Freddie Mac issued yesterday was another in a long series of reports from financial services companies showing the continued fallout from the crisis in the housing market.
"The credit deterioration has been largely driven by a decline in home prices and other declines in regional economic conditions as well as increasing volumes of non-traditional mortgage loans and less stringent underwriting standards in the last three years," the company said.
The company's financial results are heavily influenced by subjective estimates, which the turmoil in the housing market has made increasingly difficult. The company demonstrated the fallibility of such estimates when it revised one of its major predictions.
Like Fannie Mae, which last week reported a first-quarter loss of $2.2 billion, Freddie Mac said it is now forecasting bigger credit losses than it previously predicted. Measured as a fraction of Freddie Mac's total mortgage guarantees, the new estimate calls for credit losses this year to be 33.3 percent larger.
The bottom-line losses Freddie Mac has reported do not include $32.4 billion of decreases in the value of mortgage-related securities the company still holds. Those "unrealized" losses more than doubled since Dec. 31.
The company said it has not counted the unrealized losses against earnings because it expects the investments to recover.
Freddie Mac's first-quarter results benefited from a $1.3 billion expense reduction related to a change in the way it accounts for its loan guarantees under a new accounting rule.
The results also benefited from a change in the way the company manages loan guarantees. Formerly, the company bought loans from investors after they were delinquent for 120 days. Now, the company may delay that step for up to two years.
Freddie Mac said its losses from such loan purchases were $51 million in the first quarter, down from $736 million the previous quarter.