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Freddie Mac Reports More Losses From Bad Loans

By David S. Hilzenrath
Washington Post Staff Writer
Thursday, August 7, 2008

Freddie Mac, a troubled giant of the mortgage market, yesterday reported that its losses from foreclosures and other failed home loans nearly doubled during the second quarter, and it predicted that home prices would fall more than it previously projected, compounding its woes.

Days after the government put in place a federal lifeline for the company, Freddie Mac said its expenses from foreclosures and related problems rose to $2.8 billion in the quarter ended June 30 from $1.4 billion during the previous three months.

From the end of March to the end of June, the company more than doubled its reserves for anticipated losses to reflect continuing increases in mortgage delinquencies and the rising cost of disposing of foreclosed property. Falling home prices reduce the amount that Freddie Mac can recover and make it likely that even more homeowners will default.

Freddie Mac chief executive Richard F. Syron predicted that peak-to-trough declines in national home prices will average 18 to 20 percent, more than the 15 percent the company had forecast. "We now think that we're about halfway through the overall peak-to-trough decline," Syron said during a phone briefing for investors and analysts.

Overall, the McLean company lost $821 million ($1.63 per share) in the second quarter, compared with a loss of $151 million (66 cents) in the quarter ended March 31. For the second quarter of 2007, Freddie Mac reported a profit of $729 million.

Freddie Mac's stock tumbled on the earnings report, losing 19.3 percent, to close at $6.49. That was above its recent low of $3.89 but 90.3 percent off its 52-week high of $67.20.

A meltdown of investor confidence in Freddie Mac and its rival Fannie Mae last month prompted Congress and the Bush administration to lay the groundwork for a potential taxpayer bailout of the companies. The rescue legislation President Bush signed last week allows the Treasury to extend unlimited amounts of money to the companies through loans and stock purchases.

The financial erosion Freddie Mac disclosed yesterday will "if anything increase the likelihood of a government-led capital infusion," said analyst Frederick Cannon of the investment firm Keefe, Bruyette & Woods.

But Syron said he didn't expect Freddie Mac to resort to government assistance.

The extent of the company's weakness was underscored by a separate figure released yesterday. If Freddie Mac had to liquidate its holdings based on market values as of June 30, it would have been left with a shortfall of $5.6 billion, the company reported. That compared with a deficit of $5.2 billion three months earlier -- and a surplus of $31.9 billion as of mid-2007.

Freddie Mac and Fannie Mae funnel money from the financial markets to lenders so they can issue more mortgages. The companies buy loans from lenders. They also pool loans into securities for sale to other investors, promising to make the investors whole if the borrowers default.

The government adopted the rescue plan because officials feared a collapse of either company could severely damage the economy and the international financial system. At a time when many investors have fled the mortgage market, the government has been counting on Freddie Mac and Fannie Mae to keep money flowing and avert an even more disastrous decline in home prices.

To minimize the risk of the companies becoming insolvent, the government requires them to maintain certain levels of capital as a cushion against losses, and Freddie Mac said it exceeded its requirement as of June 30 by $2.7 billion. Three months earlier, the company estimated it exceeded its requirement by $6 billion.

As of mid-year, Freddie Mac was required to maintain about $34.4 billion, a small fraction of the company's trillions of dollars in investments and obligations. In a report filed with the Securities and Exchange Commission yesterday, Freddie Mac said it might not be able to stay in compliance with that requirement.

To conserve capital, Freddie Mac said it planned to reduce the dividend on its common stock in the third quarter from 25 cents to 5 cents or less per share.

The company said, as it has previously this year, that it plans to raise $5.5 billion of additional capital, adding that it may raise more. But the firm gave none of the details that investors have been awaiting as to how or when it would do so.

Like Fannie Mae, Freddie Mac promised the government early this year that it would raise additional capital in exchange for relief from a regulatory constraint. Unlike Fannie Mae, Freddie Mac has yet to fulfill its end of the deal.

Raising capital could reduce the risk that the company would require a federal bailout and increase its capacity to prop up the housing market. But raising capital could further erode Freddie Mac's profitability and water down the value of current shareholders' stock. Freddie Mac warned yesterday that it may issue new stock "in amounts that could be substantial and materially dilutive to its existing shareholders."

With its stock trading at deeply depressed prices, it would take more new shares to raise the needed funds, increasing the toll on current shareholders. During yesterday's briefing, Syron emphasized their interests, saying that raising capital now is "not the right thing to do for our shareholders."

Freddie Mac said it was considering other steps that would shore up its financial condition but reduce its support for the housing market, such as scaling back its mortgage-related investments.

Some analysts and federal officials have accused the company of operating for years with too little capital, leaving it vulnerable to a downturn in the housing market and limiting its ability to help ease the mortgage crisis once it hit.

Freddie Mac "needs to raise capital today, not wait and hope for a chance to raise cheaper capital in the future," analyst Paul J. Miller of Friedman, Billings, Ramsey Group said in a report to clients yesterday. If a lack of capital prompts Freddie Mac to curtail its mortgage purchases, that "will have a negative impact on the entire mortgage market," he wrote.

Freddie Mac ended the second quarter with $34.3 billion of unrealized losses -- declines in the value of mortgage-related investments that the company has not counted as actual losses because it predicts the investments will recover. That compared with $32.4 billion of unrealized losses as of March 31. The unrealized losses, big enough to threaten Freddie Mac's cushion, remain a cloud over the firm.

Freddie Mac concluded that some of its investments would not recover their lost value -- primarily certain securities backed by subprime loans and other mortgages issued on the basis of relaxed underwriting standards -- and it took a $1 billion write-down to account for the damage.

The company also identified another risk -- the deteriorating health of insurance companies that Freddie Mac and Fannie Mae rely upon to insulate them from losses. Freddie Mac said its $1 billion write-down was based partly on "substantial uncertainty" about the ability of one insurer to pay expected claims.

Fannie Mae is scheduled to release its second-quarter results tomorrow.

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