Freddie Mac loss widens less than feared

NEW YORK (Reuters) - Freddie Mac (FRE.N) posted a smaller-than-expected quarterly loss on Wednesday and the second-biggest U.S. home-financing company said it would raise capital to expand its business, sparking a rally in its shares.

Freddie Mac narrowed its losses in the first quarter as a result of a change in how it accounts for the mortgage payments it guarantees. That helped offset deeper credit losses suffered as more borrowers defaulted on loans.

Investors snatched up Freddie Mac shares after Chief Financial Officer Buddy Piszel said the company has "greatly reduced" the risk of losing money, freeing up the new capital to expand its business. The company also said it doesn't expect further dividend cuts.

The results showed Freddie Mac has strengthened its ability to support the crumbling U.S. housing market that many economists say is tipping the economy into recession.

Last week, rival government-sponsored enterprise, Fannie Mae, reported a massive loss and cut its dividend. The two own or guarantee nearly half of all U.S. mortgages.

The result "wasn't worse than expected and raising capital is a good thing" for growth, said Malcolm Polley, chief investment officer at Stewart Capital Advisors in Indiana, Pennsylvania. "It means Freddie's business will be able to expand and it will be used to put some sort of backstop to this mess we are in. And, the government is behind them."

The McLean, Virginia-based company said its net loss widened to $151 million, or 66 cents per share, from $133 million, or 35 cents per share loss in the same period a year earlier. It is coming off a record $2.5 billion loss in the fourth quarter.

Wall Street analysts expected Freddie Mac to post a net loss of $1.57 per share in the first quarter, according to Reuters Estimates.

While Freddie Mac benefited from accounting rules, overall credit-related expenses still jumped to $1.45 billion in the quarter from $262 million a year earlier.

"It's clear we have not yet hit bottom in the housing market," Freddie Mac Chief Executive Officer Richard Syron said on a conference call. Risks to the forecast for falling home prices this year and next "are strongly weighted on the downside," he added.

Freddie Mac raised its forecast of credit costs in 2008 to 16 basis points of its portfolio from 12 basis points.

The company is working to mitigate these losses by encouraging lenders to ease terms on homeowners. It also sent bad loans back to lenders last quarter at a pace twice as fast as in the second half of 2007 after finding originators did not meet underwriting criteria, Piszel told Reuters.

Freddie Mac shares surged 9.9 percent to $27.44 in trading on the New York Stock Exchange, although they are still down about 20 percent this year. Shares in Fannie Mae (FNM.N), also rose, climbing 7.3 percent to $30.17.

Freddie Mac and Fannie Mae have struggled since last year to maintain a balance between managing rising credit losses and their business of providing money for U.S. mortgages. Scrutiny of the companies has also intensified since they are among the few big financial institutions whose access to credit has been largely unfettered during the mortgage-led credit crunch.

The two companies have joined the ranks of banks raising capital to offset losses. Their federal regulator has encouraged them to build capital and increase exposure to the ailing housing market by lowering the minimum they must hold.

Freddie Mac said it would raise $5.5 billion in capital with common and preferred stock, likely after it completes registration with the Securities and Exchange Commission by mid-year. Fresh capital on top of the $6 billion held in excess of its current regulatory minimum, and a further easing of the regulatory surplus mandate from 20 percent to 15 percent will significantly boost the company's earnings power, Piszel said.

The company, one of the biggest investors in U.S. mortgage bonds, has already purchased about $100 billion in securities, he said. The purchases have been "essentially" Freddie Mac's participation certificates, or the mortgage-backed securities packaged and guaranteed by Freddie Mac, Piszel said.

Freddie Mac expects to see 40 percent to 50 percent growth in its investment income this year and 15 percent to 20 percent growth in its mortgage bond guaranty business, he said. The company mortgage portfolio increased in April to about $738 billion from $712 billion in March.

Piszel in March insisted the company was not planning any "dilutive" capital raise. While the capital may help the company become profitable, expected earnings are still not enough to offset the impact of shareholder dilution, said Stewart Capital's Polley, who doesn't own Freddie Mac.

Piszel said in an interview that the earnings power of the capital raised has to be considered when determining dilution.

"We are really pleased with the progress that we continued to make in the first quarter in strengthening our financial capabilities," he said.

(Additional reporting by Lynn Adler; Editing by Tom Hals)