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Freddie's Future Hinges on Recovery of Reserves

Facing future losses of between $16 billion and $42 billion - most of which are tied to subprime and alt-A loans - Freddie Mac is betting its survival on its ability to recapture loan loss reserves and related charges.

At least, that was one message company officials tried to convince analysts of last week when it posted a $821 million loss for the second quarter, and revealed a $1 billion impairment charge on its securities portfolio.

During its conference call with stock analysts, company CFO Buddy Piszel noted that 90% of the "marks" that the GSE is taking "will flow back to us."

In other words, even though the congressionally chartered Freddie is setting aside money for loan losses tied to accelerating defaults, it hopes to eventually recapture, or get the money back.

It is depending on bond insurance coverage, mortgage insurance payments and its ability to cure delinquent loans. It also believes that MBS and ABS securities that are presently underwater (not worth their original value) will one day recover.

As one stock analyst told this newspaper: "They are overly optimistic. They are saying they are right and the market is wrong."

Late last week, the market wasn't buying Freddie's arguments as its stock, once again, went into a freefall, settling at $5.89 compared to a recent low of $3.89 and a 52-week high of $67. (Its chief competitor, Fannie Mae, was on the verge of releasing its earnings as this newspaper went to press.)

Freddie CEO and chairman Richard Syron, trying to put a good face on, told analysts and reporters that at this time he has no plans to tap the new borrowing authority granted to him by the Treasury Department and Federal Reserve. He also said that the GSE is growing its purchase business nicely and that all new loans being put on its books should perform exceptionally well.

However, Freddie Mac plans to raise $5.5 billion in capital through the sale of common and preferred stock. To attract investors to the preferred shares, Mr. Syron said the GSE would have to offer a double-digit yield on the shares. He declined to be more specific.

Discussing its second-quarter performance, the company revealed that it took a $2.5 billion provision for credit losses compared to $1.2 billion in the first quarter. (Its revenue increased 11% in the quarter to $1.7 billion.)

The $821 million loss it suffered in the second quarter compares to a $729 million profit for the same period a year ago. In the first quarter Freddie lost $151 million.

Meanwhile, the secondary market giant also reported that the "fair value" of its assets fell to negative $5.6 billion, compared to negative $5.2 billion in the first quarter. (Fair value measures what their holdings are worth at current market values.)

Its core capital declined by $1.2 billion to $37.1 billion in the second quarter. It also cut its quarterly dividend to $0.05 a share from $0.25 cents to save money.

Mr. Syron said, "While we expect continued housing and economic weakness will affect our overall performance this year, we continue to maintain a surplus over all regulatory capital requirements."

However, in a filing with the Securities and Exchange Commission, the company noted that while it has "historically met" risk-based capital standards, it admitted that "there is a significant possibility that continued adverse developments" in the housing and mortgage markets could cause it to come up short on regulatory capital. (c) 2008 Mortgage Servicing News and SourceMedia, Inc. All Rights Reserved. http://www.mortgageservicingnews.com/ http://www.sourcemedia.com/

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