Freddie Mac Considers Major Stock Sale
(From The Wall Street Journal)
By JAMES R. HAGERTY, MONICA LANGLEY and SUSAN PULLIAM
NEW YORK (Dow Jones)--Mortgage giant Freddie Mac (FRE) - emboldened by emergency regulatory actions that have triggered a two-day rebound in its battered stock - is considering raising capital by selling as much as $10 billion in new shares to investors, according to people familiar with the matter.
The high-stakes maneuver would have the potential to avoid a full-blown government rescue for Freddie Mac and Fannie Mae (FNM), twin keystones of the U.S. housing market. The publicly traded, government-sponsored companies own or guarantee about $5.2 trillion of home mortgages, or nearly half the total outstanding, and are at the center of government efforts to prop up the sagging housing market.
Both companies' stock fell about 45% last week amid worry about whether they have enough capital to cover mortgage losses. The depth of their troubles spurred the Treasury Department on Sunday to unveil an unusual plan to temporarily extend an unspecified credit line to both companies - as well as buy stock in them if necessary.
That plan quickly came under fire on Capitol Hill. Critics argue it could cost American taxpayers billions of dollars.
For its part, Freddie would like to avoid the stricter government oversight that could accompany any rescue. Its moves come as new details emerge about its recent stumbles.
The past two days have raised hopes at Freddie for a sale of shares to investors other than the Treasury. Freddie and Fannie shares both surged more than 29% on Wednesday, a day after the Securities and Exchange Commission set emergency rules limiting the ability of bearish investors to place aggressive bets that their stocks would keep falling.
On Thursday, Freddie shares were up another 22%, though they remain down 76% for the year.
A sale by Freddie of common and preferred stock could be tough to pull off. For starters, the preferred shares would require Freddie to offer a very high rate of return to attract buyers. The yield on one existing issue of Freddie's preferred stock, for example, is about 13.8%. At that rate, even a $5 billion preferred-stock offering would entail a $690 million annual payout, on top of the $272 million Freddie paid out on its existing preferred shares in the first quarter. That would reduce the money available to common-stock shareholders, cutting the value of those holdings and potentially sending the stock price lower.
The main buyers for any new-stock issues are likely to be existing shareholders world-wide, according to one person involved in the discussion, adding that a definitive plan hasn't yet been determined.
In the short term, a sale of new shares might eliminate the need for the Treasury's help, but a government bailout might still be required later. "At the heart of this crisis of confidence is uncertainty about the true financial condition of the companies," says Armando Falcon Jr., their former regulator.
Analysts expect that Freddie and Fannie both will face significant losses in the months ahead as the housing crisis shows no signs of slowing. Both companies, which were originally chartered by acts of Congress, buy mortgages from lenders. They package those loans into securities for their own investment portfolios and for sale to investors world-wide.
The two companies - which are rivals in the same business - have reported a combined $11 billion of losses over the past three quarters, largely because of increasing defaults by homeowners on mortgages. When homeowners don't make mortgage payments, Fannie and Freddie must reimburse the holders of securities backed by those defaulting mortgages. At the same time, falling home prices cut the value of the collateral backing the loans, increasing losses for Fannie and Freddie.
Investors and analysts can only guess how bad the losses might be as several million American homes go through foreclosure. Analysts at Goldman Sachs Group Inc. this week estimated that Fannie faces default-related losses of $32 billion and Freddie $21 billion. Those losses, expected to be mostly realized over the next few years, will be offset to some extent by growing revenues and higher fees the companies can now charge.
Freddie's board met Thursday to review options for selling new shares. Freddie Mac Chief Executive Officer Richard Syron has huddled frequently with investment bankers from Morgan Stanley and Goldman Sachs Group Inc. and has held two board meetings this week at Freddie's New York office. The proceeds of a sale are expected to be in the range of $5 billion to $10 billion, according to people close to the discussions.
One idea that has been raised is a "rights offering" of shares, in which existing shareholders get first dibs on the new stock. Freddie, for its part, says it has plenty of cash for now and has hinted that it could resort to eliminating its dividend, for savings of $650 million a year.
In an interview, Mr. Syron said Freddie's board has been discussing "the full array of options before us," declining to give specifics. He said it was too early to specify when Freddie would raise capital, adding: "We're not at the stage of talking about the exact when."
The push to court private investors, rather than accept government money, illustrates how much Freddie Mac wants to avoid the potential for additional government controls. Congressional approval of a government bailout would likely entail new restraints on how it conducts business.
For instance, if loans or investments are made with government money, lawmakers are weighing provisions to prevent the two companies from paying dividends to shareholders or issuing big paychecks to their management, says Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee. Government assistance could require Fannie and Freddie to consult the government "before it can even pay its water bill for the toilet," Rep. Frank said in an interview. He supports what the Treasury has proposed, which is to provide money for the two companies if needed.
Mr. Syron said he hopes he won't need the government's help, or face the possible consequences, such as getting bills approved by the federal government. "I'm kind of partial to indoor plumbing," he quipped during an interview, in response to Rep. Frank's comment.
The discussions come as both Freddie and its bigger rival, Fannie, continue to struggle to balance their shareholders' desire for big profits and the government's demand that they provide plenty of funding for home loans, even if that hurts their profits in the short term.
It's unclear how shareholders would react to the plan. At least one shareholder, David Dreman, whose Dreman Value Management owns more than 10 million shares, says Freddie might benefit from waiting a month or so to do such an offering. "Yields may go down and prices could go up after the government's initiatives kick in," says Mr. Dreman. "There shouldn't be such a rush to get to the party at this point." Still, he says, it is good corporate governance to give existing shareholders first dibs.
The government's proposal to offer a rescue if needed means that, for the time being, Freddie and Fannie are effectively wards of the state. As a result, taxpayers would pay the bill if either company were to fall apart.
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