Freddie Mac (NYSE:FRE) put on a good show with its first quarter report, but accounting changes and worries about the housing market left some wondering whether the report was all fluff. I, for one, was not expecting any good news from Freddie Mac or its sister company Fannie Mae (NYSE:FNM), so I viewed the headline news with skepticism. Upon closer examination, there are still major concerns for the mortgage giant.
Accounting Changes Reduce Losses
On Wednesday, Freddie Mac reported a first-quarter loss of $151 million (66 cents per share), better than consensus analyst expectations of a 92-cent per-share loss. The news helped lift the shares 9%. The jump in the stock looked more justified than the jump Fannie Mae received after its abysmal $2.2 billion first-quarter loss, but the slimmer-than-expected losses from Freddie were not that special.
The company softened losses through some accounting changes. Freddie reclassified $90 billion in securities, which helped boost the bottom line around $1 billion from the fourth quarter, and another change related to mortgage guarantees, helped stave off another potential $1 billion dollar hit. It is easy to see that this is not something to rejoice about, but then again, investors have not been acting 100% rational with shares of Fannie and Freddie, in my opinion. (For help cutting through the clutter of a complex earnings report, read our tutorial on Advanced Financial Statement Analysis.)
More Troubles, More Dilution
Freddie also saw its balance sheet weaken significantly during the quarter. A measurement of the company's total assets actually turned to negative $5.2 billion from $12.6 billion at the end of last year. In another troubling sign for Freddie, it is leveraged massively. Freddie has a leverage ratio of 50.2 times, compared with 21.7 at Fannie Mae, and 17.2 at Citigroup (NYSE:C). In unsurprising but trailing news, Moody's (NYSE:MCO) downgraded Freddie's financial strength rating, and estimates that the company will be hit with $7.5 billion in losses over the next two years. Freddie stated that it plans to sell $5.5 billion of common and preferred stock to try and strengthen its balance sheet.
This has become a recurring theme with these mortgage giants. The companies have to do it, because their balance sheets are being hacked up, but it is continuing bad news for investors. Regulators decided recently to allow Fannie and Freddie to take on more loans.
This can potentially be a good sign, but can also just be adding more junk onto the books of these companies. All of this will cause Freddie and Fannie to keep raising capital and keep diluting the shares. I would not want to touch these stocks. (Explore further how company debt can pose a threat to investors in When Companies Borrow Money.)
The Bottom Line
Freddie released numbers that created headline buzz, and sent the shares up, but did nothing to get me excited. The beat was mostly due to accounting changes and does nothing to show a true improvement in the company. Freddie's balance sheet and financial strength has continued to deteriorate, causing it to raise more capital. The story has not changed on this stock.
To learn about the systemic risks Fannie and Freddie pose, read Fannie Mae And Freddie Mac, Boon Or Boom?