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Freddie Mac’s third-quarter loss widens

The mortgage crisis intensified Tuesday as Freddie Mac, the nation’s No. 2 buyer and guarantor of home loans, posted its largest quarterly loss ever.
/ Source: Reuters

The mortgage crisis intensified Tuesday as Freddie Mac, the nation’s No. 2 buyer and guarantor of home loans, posted its largest quarterly loss ever and warned that it may need to curtail its business unless it can raise fresh capital.

Freddie Mac lost $2 billion in the third quarter, much more than Wall Street was expecting, primarily because it needed to set aside $1.2 billion to account for bad home loans. Freddie Mac also said it may slice in half its quarterly dividend of 50 cents per share — which would be its first dividend cut since becoming a public company in 1989.

That double dose of bad news sent Freddie Mac’s shares skidding 28.7 percent, the largest decline in the two decades its shares have traded in public markets.

It also sent a shudder through the mortgage market since Freddie’s loss was even larger than the $1.4 billion quarterly deficit of Fannie Mae, its bigger government-sponsored competitor. Shares of the nation’s largest mortgage lender, Countrywide Financial Corp., dropped on worries that one of its main sources of sales could dry up.

Analysts noted that Freddie Mac’s holdings of securities backed by high-risk subprime mortgages — the loans targeted to borrowers with tarnished credit records that succumbed to a wave of defaults starting earlier this year — greatly exceed those of Fannie Mae.

The remedies Freddie Mac is contemplating could add to the strain on the slumping housing market, analysts say, an outcome that would be sharply at odds with its government-mandated mission to keep money flowing to lenders.

Fannie Mae and Freddie Mac have traditionally been a key source of funding for banks and other mortgage lenders by purchasing mortgages they originate and then packaging them for sale to investors. Industry experts say a reduced role by either could ripple across the entire housing market.

The two “have provided essential liquidity in a time of crisis,” Fox-Pitt, Kelton analyst Howard Shapiro said in a research note Tuesday. “Now that that liquidity function has essentially been withdrawn, it will mean, in our opinion, a further exacerbation of the housing downturn — even less credit available and steeper downturns in home prices.”

Executives of McLean, Va.-based Freddie Mac said Tuesday there was little to be optimistic about in the current quarter and told investors to brace for more of the same.

“This is a very, very difficult time. This is not happy news,” Freddie Mac’s chairman and CEO, Richard Syron, said in a conference call with Wall Street analysts. “We will work through this.”

Freddie Mac said it is “seriously considering” cutting in half its dividend in the fourth quarter and has hired Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. as financial advisers to help it examine possible new ways of raising capital.

If dividend cuts and other actions aren’t sufficient to keep the company’s capital levels above government-mandated minimums, Freddie Mac said it may consider other measures such as limiting its growth, reducing the size of its mortgage investment holdings or issuing new stock.

The company likely will raise capital by selling several billion dollars of preferred stock in the “very near term,” the company’s chief financial officer, Buddy Piszel, told The Wall Street Journal Tuesday. Analysts said that could amount to $5 billion to $10 billion.

In another sobering report Tuesday, the federal Office of Thrift Supervision said third-quarter profits at the nation’s 831 savings institutions plunged 84 percent to $704 million, as they felt the brunt of the housing market’s downturn. The savings and loans set aside millions for anticipated loan losses in the quarter.

James B. Lockhart, head of the Office of Federal Housing Enterprise Oversight, which regulates Fannie and Freddie, said Freddie Mac’s announcement of the actions it is planning “reflects prudential actions for the company that are appropriate in light of current market conditions.”

Fannie and Freddie, along with some lawmakers, had been pressing Lockhart in recent months to let the two institutions buy even more mortgages as a way of calming jittery markets. The mandated cap was increased 2 percent to $735 billion several months ago.

But with Freddie Mac now looking at retrenching, and both companies having recently reduced their investment holdings, questions have now been raised about their financial health.

Wall Street agency Fitch Ratings, meanwhile, put some of Freddie’s securities on “rating watch negative” after the company’s announcement, citing “recent and potential future challenges” in meeting the mandated surplus capital levels.

Piszel, the finance chief, said Freddie Mac is moving to stem losses.

“We have begun raising prices, tightened our credit standards and enhanced our risk management practices,” Piszel said. “We also continue to improve our internal controls.”

Freddie’s third-quarter loss was almost triple the $715 million deficit during the same period last year. And because of accounting adjustments, it reported negative revenue of $678 million, compared to positive revenue of $91 million a year earlier.

The $2 billion third-quarter loss for Freddie Mac worked out to $3.29 a share, compared with $1.17 a share in the third quarter of 2006. Losses far exceeded Wall Street analysts expectations of a 22 cent per-share deficit, projected in a poll by Thomson Financial.

Freddie Mac’s regulatory core capital was estimated to be just $600 million in excess of the 30 percent mandatory target capital surplus directed by the OFHEO.

So far this year, Freddie Mac has recognized $4.6 billion in pretax credit related items.