Freddie Fretting

By, 11/20/2007

Story Highlights:

  • Market jitters tied to housing credit problems were stoked by Freddie Mac's announcement of a $2 billion loss today.
  • While analysts proclaimed "this is as bad as it gets," the losses are relatively shallow and barely can be said to resemble a corporate (let alone economic) crisis.
  • Meanwhile, the Fed sees benign inflation and continued economic growth on the horizon as Wall Street titans quietly move to scoop up undervalued assets amid the tumult.


(Editor's Note: MarketMinder does NOT recommend individual securities; the below is simply an example of a broader theme we wish to highlight.)

Freddie Mac, the second-largest U.S. mortgage-finance company, posted a record loss today of about $2 billion, and the stock sank in excess of 25%.

Freddie Posts Loss, May Cut Dividend; Shares Plunge
By James Tyson, Bloomberg

According to the article, Howard Shapiro at Fox-Pitt Kelton said, "It's as bad as it possibly could be." What great news! We hope he's right! If this is as bad as the news could be, then consider:

  • Freddie's net loss is about $2 billion out of a loan portfolio over $710 billion. In other words, the loss amounted to less than 3 tenths of a percent of its loan portfolio.
  • Similarly, Freddie's balance sheet seems to be holding up pretty well, particularly by comparison to, say, Merrill Lynch, which wrote down $9 billion of its assets tied to mortgage-related securities products a few weeks ago. (And even at that, we still don't view Merrill's problems as a major obstacle for future growth.)

All of this carnage could force Freddie to…horror of horrors…reduce its dividend. Oh, eternal sadness! Notice we're not talking significant impairment of assets, or even a long-term alteration of the way Freddie conducts business, just a reduction in quarterly investor payout.

Now, if you're a Freddie shareholder that certainly stings. But if you're looking at Freddie as a proxy for mortgage market health (as many do), this ain't so bad. In reality, losses from the so-called credit crisis continue to be relatively shallow. We'd be so lucky to have all our credit problems turn out like this.

Skeptics might counter by saying Freddie has just $8.5 billion cash in excess of the regulatory minimum capital requirement, and only $600 million in excess of the mandatory capital surplus directed by the Office of Federal Housing Enterprise Oversight (OFHEO). As a result, Freddie may have to raise some additional cash to maintain minimum requirements. Which begs the question: Is Freddie solvent? Even begging the question is scary for many. Only one problem: Capital requirements and financial health are two very distinct issues.

Even after losses recorded today, Freddie still has core capital of over $34 billion, which is about on par with what's mandated by OFHEO. This "requirement" is an arbitrary number set by a regulatory commission, not a measurement of true financial health. Freddie might need additional capital in the short-term to meet a requirement, not because it actually needs the cash.

In our view, the key takeaway of today's Freddie fretting is a continuation of negative market overreaction over credit worries.

There's no doubting the housing market is soft, and some of the riskier loans are being reassessed. But the notion we're on the precipice of economic Armageddon tied to credit problems continues to defy reason and reality.

Amid the gloom, we've noted a number of under-the-radar moves from Wall Street titans, looking to scoop up assets on the cheap:

Greed Trumps Fear as KKR Gets Banks to Arrange CLOs
Caroline Salas and Pierre Paulden

This is more telling than anything Freddie had to say—the smart money continues to seek value. We hope you do the same.

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.


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