Freddie Mac's negative net worth raises questions

NEW YORK (Reuters) - By Freddie Mac’s own admission, it has a negative net worth -- the latest reported net market value of the mortgage giant’s assets is negative $5.6 billion.

To some investors, that means its shares should be trading closer to zero. Bears argue that the company’s bonds are a reasonable investment given the U.S. government’s increasingly explicit support, but its shares are a more questionable investment.

Freddie Mac’s shares moved closer to zero on Wednesday, dropping nearly 20 percent to $6.49 after it posted a much-wider-than-expected quarterly loss of $821 million.

But Freddie’s $4.2 billion market capitalization signals that at least some investors still see value in the company.

“Investors are betting that Freddie Mac can keep the show going long enough for either a recovery in the economy or the housing market, or to get help from the government,” said Dan Alpert, managing director at investment bank Westwood Capital.

There may be some sense to that bet. The U.S. housing market is showing early signs of bottoming out, even if it is not yet recovering. A report last week said home prices in May in 20 major regions fell 0.9 percent from April, which was less than expected and not as severe as the prior month.

And some investors believe market values for many mortgages are distressed, and will rise again as the housing market stabilizes, meaning that fair value may not accurately reflect the real value of the assets.

But few deny that the mortgage market is aching now.

“Today’s challenging economic environment suggests that the housing market is far from stabilizing,” Freddie Mac Chief Executive Richard Syron said on a conference call with analysts and investors. “We now think that we are halfway through the overall peak-to-trough decline.”

Investors are manifestly concerned about the stability of Freddie and larger sibling Fannie Mae, which together own or guarantee just under half the country’s $12 trillion of mortgage debt. Freddie’s shares have lost nearly 90 percent of their value in the last year, and Fannie’s nearly 80 percent.

Freddie and Fannie faced a storm of stock selling in July as investors speculated they would fall short of the capital needed to offset losses sustained from delinquent mortgages and help stabilize the housing market. The U.S. government arranged emergency measures to provide extra support to the companies.

CAPITAL HOPES

Freddie Mac hopes to raise $5.5 billion of additional capital to bolster its balance sheet, but in a sense that would just bring it back to about zero: the company’s assets had a negative $5.6 billion net fair value at June 30, compared with their accounting value of $12.9 billion, according to financial statements Freddie posted on Wednesday.

“I think there’s plenty of reason in today’s report to think that $5.5 billion might not be adequate,” said Frederick Cannon, chief equity strategist at Keefe, Bruyette & Woods in San Francisco.

To the extent that the government provides extra support for Freddie Mac, it might be painful for equity holders, Westwood’s Alpert said.

“Either investors are going to be massively diluted given the amount of equity they are going to need or they are going to be nationalized,” Alpert said.

A Freddie Mac spokesman declined to comment.