To Investors, Freddie's Cushion Was Thin

In a conference call with analysts, Richard Syron, chairman and chief executive officer of Freddie Mac, said "well, there are obviously lots of different ways that people can look at capital." (By Jb Reed -- Bloomberg News)

In addition, Freddie Mac is counting as assets about $18.4 billion in deferred tax credits. The credits are useful if Freddie Mac can apply them against profits, but the company has been reporting quarter after quarter of losses. If Freddie Mac were to conclude that the odds of its being able to use tax credits are no greater than 50 percent, it would have to write them off, taking a potentially big bite out of its capital.

"If we haven't gotten to the point where a write-off is going to be imposed by the accountants, we're no more than a quarter away," and the charge could reach $10 billion, said Robert Willens, a consultant on tax and accounting issues.

In a regulatory filing, the company said it doesn't think such a write-down is needed because it expects the downturn in the housing market to be temporary.

Merrill Lynch this week issued a report saying Freddie Mac probably would not deplete its capital for several quarters and predictions of an imminent bailout might be premature.

Freddie Mac's Aug. 6 conference call was one of the company's most pointed efforts to address concerns about its capital. The chart on page 11 of the presentation showed how much capital Freddie Mac estimated it would have, above the government's "statutory minimum requirement," in an array of hypothetical scenarios involving increasingly large write-downs of mortgage investments and other costs related to bad loans.

"While we are not expecting the most severe outcomes reflected in this analysis, what it shows is that we can withstand approximately $40 billion of credit pain for all of '08 and '09, and essentially meet our minimum statutory capital requirements," chief financial officer Anthony "Buddy" Piszel said on the conference call.

Freddie Mac spokesman Michael Cosgrove said that the company has incurred about $8.25 billion of such expenses since the housing downturn began last year.

The chart conservatively assumes that Freddie Mac will maintain its current level of mortgage investments; if it reduced them, it would need less capital.

For several reasons, however, the chart was less reassuring than it might have seemed.

First, as a footnote to the chart explained, and as Piszel noted, the numbers were based on an assumption that Freddie Mac had fulfilled its long-standing plan to raise an additional $5.5 billion of capital. Freddie Mac has yet to raise the $5.5 billion and faces difficulty doing so. The stock market currently values the company at $3.4 billion.

Second, the chart sought to illustrate Freddie Mac's ability to meet the "statutory minimum requirement," but that is not the only measure of capital adequacy the company must meet. Even if Freddie Mac remains in compliance with that requirement, falling short of another standard known as the risk-based capital requirement can trigger the same consequences.

The risked-based requirement focuses on the grades that credit-rating agencies such as Moody's and Standard & Poor's assign to mortgage securities in the company's investment portfolio. The risk-based standard becomes more stringent as the securities are downgraded.

"While we have historically met the risk-based capital standard, there is a significant possibility that continued adverse developments . . . could cause us to fail to meet this standard," Freddie Mac said in a report filed with the Securities and Exchange Commission. "If we were not to meet the risk-based capital standard, we would be classified as 'undercapitalized,' " the company reported.

Third, following an accounting scandal at Freddie Mac, a federal regulator directed Freddie Mac to maintain more capital than the statutory minimum -- currently, 20 percent more. The extra requirement, which the company said it exceeded by $2.7 billion on June 30, is not reflected in the chart.

"The chart was constructed in this way for ease of presentation," Cosgrove said by e-mail.

During the conference call, an analyst asked the Freddie Mac chief executive about other ways of looking at the company's capital needs.

"Well, there are obviously lots of different ways that people can look at capital," Syron said. "And the framework that we're working within now is the statutory framework, and that's the reason that we are focused on it."