Heavy credit losses are forcing Freddie Mac to husband its capital, and that means a surge in the government-sponsored enterprise's purchases of mortgage assets in the second quarter will be short-lived.
Freddie said Wednesday that it had seized an opportunity to buy mortgage securities that it guarantees on the cheap. As a result, its retained portfolio grew at an annual rate of 45%, to about $792 billion, helping to drive a doubling in net interest income, to $1.5 billion, in the quarter.
But the GSE said it expects to hold the portfolio at that size because of caution over its capital position. A doubling of its provision for credit losses, to $2.5 billion, and $1 billion of impairments led to a more than fourfold increase in Freddie's net loss from the previous quarter, to $821 million.
"If credit wasn't a concern, it would be a good use of capital to continue to grow the portfolio," Anthony Piszel, Freddie's chief financial officer, said in an interview. "Spreads continue to be wide relative to our funding costs."
Freddie's cushion over its 20% regulatory capital surplus target fell by about half since the end of the previous quarter, to $2.7 billion at June 30.
"I give them another couple quarters here at most before they breach" the 20% surplus requirement, "unless they turn around and start selling assets from their portfolio," said Rajiv Setia, an analyst with Barclays PLC's investment bank in New York. "But that would be a very, very dire scenario for the mortgage market."
To help address the capital problem, the GSE said it would slash its dividend from 25 cents to 5 cents or less in the third quarter.
It said it still intends to raise $5.5 billion in a share offering, though the timing remains uncertain. On a conference call with investors, Mr. Piszel said, "We believe we can manage to maintain our capital position for some time. So we're not putting a date certain" on the stock offering. "There's no need for us to rush."
Freddie cited the turbulent market conditions that drove a sharp drop in its share price as one of its considerations, though in the interview Mr. Piszel said, "We have not specifically pegged our actions to any specific stock price."
On the call, Richard Syron, Freddie's chairman and chief executive, said: "We're prepared to go as early as today to raise that money. But we think and have been advised that that's not the right thing to do for our shareholders."
In the meantime, Mr. Syron said, Freddie has "lots of different ways that we can manage capital," including allowing the retained portfolio to run down.
Patricia Cook, Freddie's chief business officer, said on the call that the GSE "effectively bought back the supply [of mortgage securities] we were originating" through its portfolio purchases during the quarter, "thus supporting 30-year fixed mortgage rates."
Paul Miller, an analyst at FBR Capital Markets Corp., asked on the call whether reduced portfolio purchases would increase mortgage rates. Ms. Cook replied that the market may already be pricing for the GSEs' constrained capacity.
"Spreads right now are a little bit wider than they have been recently, which probably reflects that expectation," she said. But "even with the portfolio flat, we think we can continue to support the market" by replacing runoff and continuing "to reposition the portfolio so that we can support the secondary mortgage market."
Freddie presented a model showing that with cumulative loss provisions and expenses for repossessed properties of $29 billion and impairments of $12 billion this year and next, it would fall only $700 million below its statutory minimum capital, which does not include the surplus requirement. The analysis assumed that the GSE would raise the $5.5 billion of new capital.
Mr. Setia said that to inspire confidence in the housing markets, "you want … [Freddie] to have way, way excess capital as opposed to just enough according to some definition that was crafted 15 years ago."
In a research note published after the call ended, Mr. Miller wrote that Freddie "needs to raise capital today, not wait and hope for a chance to raise cheaper capital in the future." He estimated that the company needs to raise $10 billion to $15 billion, which would be highly dilutive.
Freddie's "sitting on the sidelines" by pulling back on purchases for its portfolio "will have a negative impact on the entire mortgage market," Mr. Miller wrote, because it would have less ability to help "keep mortgage rates low."
Mr. Syron said the GSEs must become "elastic institutions" that expand quickly during downturns and pull back when times are good. Hence, their capital requirements should be "treated in a countercyclical rather than a pro-cyclical way."
Freddie's shares fell 19% Wednesday. Fannie Mae's fell almost 15%.