FBR analyst Paul Miller reiterated his Underperform rating on Freddie Mac (FRE) and cut his price target from $7 to $5, citing “continued pressure on capital from credit losses.”
Given Freddie’s massive $824 million loss, Miller is concerned that Freddie’s growing net interest income will continue to be offset by credit losses and writedowns on securities. Freddie’s reserve of surplus capital declined from $3.3 billion to $2.7 billion and Miller is urging FRE to raise capital ASAP:
We applaud FRE for cutting the dividend and backing off growth in the retained portfolio in order to preserve capital. However, FRE needs to raise capital today, not wait and hope for a chance to raise cheaper capital in the future. In addition, as one of the largest net buyers of mortgages, FRE sitting on the sidelines will have a negative impact on the entire mortgage market. Fresh capital would allow FRE to participate in the market to help stabilise the mortgage market and keep mortgage rates low.
Concerning Freddie’s outlook, Miller remains sceptical. Freddie’s capital concerns are real, and its regulatory capital requirements are built for a different kind of credit environment. Miller thinks that FRE needs between $10 billion and $15 billion:
We remain cautious on FRE for the long term, as we believe rising credit cost will not be offset by strong top-line growth. The current GSEs’ capital rules are outdated, based on low levels of historical losses on mortgage assets. We continue to estimate that FRE needs to raise $10 billion to $15 billion, and dilution from the capital raise will be significant. A $10 billion capital raise at $5 per share would result in a 65% dilution to current core book value.
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