Companies try to sell new stock to investors when market conditions are favorable so they can raise the most cash. Freddie Mac may have no choice.
Huge home loan losses that have the company planning to raise capital as the housing market's meltdown worsens reflect the severity of the mortgage finance giant's woes.
Lenders, investors and consumers may continue to question the financial health of Freddie Mac and its government-sponsored sibling, Fannie Mae. After the staggering quarterly losses announced this week by the government-sponsored enterprises, they are no longer viewed as the stalwarts of the mortgage industry.
Bigger-than-expected mortgage losses resulted in McLean, Va.-based Freddie Mac saying this week it may halve its dividend in the fourth quarter. It has also hired Wall Street financial advisers to help it examine how to raise capital quickly so that it maintains its capital reserve requirements.
Freddie Mac's shares sunk 74 cents, or 2.8 percent on Wednesday to close at $26 after plunging more than nearly 40 percent the past five trading sessions. Fannie Mae's shares rose 98 cents, or 3.5 percent to close at $29.23 Wednesday after plunging more than 35 percent the past five sessions.
Analysts expect Freddie Mac to soon raise as much as $5 billion, potentially through a preferred debt offering that will be convertible to stock, diluting the value of outstanding shares.
While that could further depress Freddie Mac's battered stock price, company executives appear to prefer that option to cutting back on the company's mortgage holdings.
On a conference call with investors Tuesday, Richard Syron, Freddie's ceo, said the company could hunker down, allow its mortgage business to shrink naturally and wait for the problems to subside. Because some home loan borrowers pay off their mortgages every month, the companies' mortgage holdings naturally decrease unless they are replenished.
But Syron said it is in the best interest of the mortgage market and shareholders to "get in front of the situation" and raise more capital. Freddie Mac executives say the current problems, while bad for short-term profits, are a strategic long-term play for Freddie to emerge strong after the housing market crisis ends.
Some analysts say they are confident that Freddie and Fannie, although not insured by the federal government, will survive their financial woes.
James B. Lockhart, head of the Office of Federal Housing Enterprise Oversight, which regulates Fannie and Freddie, said in an interview Wednesday that both companies "have the wherewithal to weather the storm."
He said he is opposed to efforts to lower the companies' capital requirements, which protect them from unforeseen losses. Given the current rocky market, "it's important to keep that cushion," he said.
Some analysts warn that the worst is not over despite Freddie Mac's $2 billion loss in the third quarter and Fannie's $1.4 billion loss in the same period. Estimates of further losses up to $10 billion each floated around Wall Street Wednesday.
"Neither Fannie nor Freddie have enough capital to really withstand serious losses," said R. Christopher Whalen, managing director of Institutional Risk Analytics, a consulting firm. He pointed to potential big hits from mortgage-backed securities that Fannie and Freddie hold in their investment portfolios.
"They could end up insolvent," Whalen said. "I think ultimately the government is going to have to take over one or both of these organizations."
Whalen and other critics have long argued that the companies pose a risk to the financial system because of the massive size of their mortgage holdings. This year, Congressional Democrats pushed for an expansion of a federally set portfolio cap currently at $735 billion. They said an increase would help stabilize the seized-up market for mortgage-backed securities, bundles of home loans bought and sold by institutional investors.
Bert Ely, a banking consultant based in Alexandria, Va. agrees the companies likely face severe fourth-quarter losses as they recalculate the market value of the mortgage-backed securities they hold due to declining values for securities backed by mortgages given to borrowers with weak credit records.
Nevertheless, Ely agreed that the problems are likely not fatal. "There's a lot they can do it, if they put their mind to it," Ely said.