RealMoney Silver - FRE Preview: Can Disaster Be Averted?

FRE Preview: Can Disaster Be Averted?
By Vasu Vijayraghavan
RealMoney contributor
5/13/2008 10:07 AM EDT

Analysts anticipate disastrous first-quarter 2008 earnings for Freddie Mac (FRE) , expecting deepening losses of 93 cents per share, a 102% decrease from the loss last quarter of 46 cents per share. However, despite everything, revenue is expected at $1.44 billion, a 240% increase from last quarter's $424 million. While the stock declined by 26% last year, the question on investors' minds is whether Freddie Mac's anticipated $6 billion sale of short-term bills, on the heels of rival Fannie Mae's (FNM) $2.3 billion offering of convertible stock, will change the scenario for the company for 2008.

There are some bright spots for the mortgage refinancer, though. Despite the fact that last year, Freddie Mac posted a loss of $5.37 per share, there were some components of its portfolio that bucked the overall trend. For instance, the value of its investment portfolio stayed flat, instead of declining. Freddie Mac's weakest segment was the core single-family guarantee units, where income posted a loss of $256 million, but the bank stepped in aggressively to purchase multi-family mortgages, increasing this portfolio by 50%, to $18.2 billion and realizing $398 million of income, which represented a slight decline from the $434 million income in 2006.

In particular, the company believes that fundamentals for multi-family units remain favorable, due to demographic factors and higher immigration, favoring rental housing over owned units. A limited supply of zoned land as well as barriers to entry brighten the perspectives for this part of the housing market. Furthermore, despite an overall slowdown in the housing market, total mortgage debt grew last year by 7%, and the company expects a continued increase in mortgages issued over 2008, although at a slower rate.

Despite these mildly optimist predictions, Freddie Mac is struggling with problems that may be insurmountable. For instance:

Provisions for credit losses increased by 850%, to $38 million last year.

The value of its non-mortgage-related securities portfolio saw significant deterioration, declining by 23%, to a face value of $35 billion, of which asset-backed securities declined in value by 48%, to $16.6 billion.

Total non-performing assets increased by 93%, to $18.4 billion.

While there was some stability in the net interest yield, it reported at an extremely low value of 0.44%.

The derivatives portfolio declined in the value by 37%.

The REO portfolio increased by 176%.

An increase in the proportion of Alt-A component of single-family units by 30% over 2007.

On the other hand, Freddie Mac did realize significantly higher gains on trading securities due to the decline in long-term rates, resulting in gains to the company's Real estate mortgage investment conduit portfolio. In addition, the bank realized slightly higher fees for its securitization issuances. Given that the outlook for 2008 has the company significantly increasing its position in mortgages with higher unpaid principal balances, however, it's not clear that younger renters can do much to save the situation of their elders who are owners, nor whether they can help bail out Freddie Mac from its current troubles.

At the time of publication, Vijayraghavan had no positions in the stocks mentioned.

Vasu Vijayraghavan was an academic finance professor at the University of Paris who has now turned to a new career as a financial consultant. As an academic, she wrote on corporate governance issues, especially in the European context, and she believes in a long-run and balance sheet approach to stock picking.

Currently, Vasu is working as a consultant for lawyers, doing business valuation. She is a Level II CFA candidate and enjoys writing long/short and earnings calls pieces for TheStreet.Com.

Vasu holds a Ph.D. from the University of Michigan and a B.A. from Harvard University.

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