Freddie may need to raise capital in Q3: Merrill Lynch

(Reuters) - Freddie Mac may have to raise $5.5 billion in capital as early as the third quarter, instead of second quarter of 2009, an analyst at Merrill Lynch said.

Shares of the company fell as much as 13 percent following Merrill's comments and a report from Barron's that said the U.S. Treasury was likely to recapitalize Freddie and Fannie Mae in the months ahead.

Fannie Mae's shares were down more than 13 percent at $6.84 in morning trade on the New York Stock Exchange.

Analyst Kenneth Bruce of Merrill Lynch said many investors have already priced in the share dilution and a stricter federal regulator may demand higher capital levels from Freddie.

"We think the market stand-off will continue, so if investors are already pricing in dilution and Freddie is on the proverbial hook to raise capital, then it might as well get the event behind it," Bruce said in a note to clients.

The capital issuance is likely to consist of at least 50 percent of common shares, he added.

Earlier Monday, Barron's also said the Treasury's move could wipe out existing holders of both Freddie and Fannie's common stock, with preferred shareholders and debt holders also suffering losses.

The analyst, who has an "underperform" rating on the stock, cut his price target to $5.75 from $7, citing future uncertainties regarding credit results and policy responses to stabilize the housing and mortgage markets.

"We do not think policy makers will support Freddie taking a more risky approach to capital adequacy," Bruce said, adding that the U.S. government would end up shouldering the burden, if actual losses were near the high-end of the $15 billion to $43 billion range.

The analyst said that with political sensitivities high before the November elections, a government rescue would be an undesirable option and policy-makers could force further public capital issuance on Freddie Mac.

Freddie's shares were trading down 75 cents at $5.10 Monday morning on the New York Stock Exchange. The stock has lost about 83 percent so far this year.

(Reporting by Adheesha Sarkar in Bangalore; Editing by Amitha Rajan)