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Freddie Mac’s (OTCQB:FMCC) second quarter 2010 net loss came in at $1.85 per share, substantially lower than the prior quarter loss of $2.45. However, this compares unfavorably with a net loss of 26 cents per share in the year-ago quarter.

With some early signs of stabilization in the housing market, Freddie Mac expects low mortgage rates, relatively high affordability and homebuyer tax credit, all of which will help fuel a recovery in the upcoming quarters. Though provision for credit losses showed some improvement over the prior quarter, it remained at an elevated level as the credit market continued to deteriorate.

In June, Freddie Mac announced that it will no longer be allowed to trade its shares on the New York Stock Exchange, having failed to maintain listing standards with lower-than-minimum price requirements. But the company will continue to file reports with the Securities and Exchange Commission (SEC) and also, remain subject to federal securities laws. From July onwards, the shares of the company are trading over the counter.

Quarterly Performance

Net loss (excluding preference dividends of $1.3 billion) for Freddie Mac came in at $4.7 billion, compared with $6.7 billion in the prior quarter and a net income of $302 million in the prior-year quarter. The sequential decline was mainly due to lower derivative losses and a lower provision for credit losses.

Fully taxable-equivalent net interest income was $4.1 billion for the reported quarter, almost flat compared with the prior quarter and lower than $4.3 billion in the year-ago quarter.

Net interest yield on a fully taxable-equivalent basis was 0.70%, up 2 basis points (bps) sequentially. The increase in net interest yield was primarily driven by lower funding costs, which were partially offset by a decline in the average balance of Freddie Mac's investments in mortgage-related securities.

Non-interest loss for the quarter came in at $3.6 billion, compared with $4.9 billion in the prior quarter and an income of $3.2 billion year over year. Non-interest income for the quarter included derivative losses of $3.8 billion, compared with derivative losses of $4.7 billion in the prior quarter.

Non-interest expense of $0.5 billion was lower than $0.7 billion in the prior quarter and $1.7 billion in year-ago quarter. The decline in non-interest expense was mainly due to income of $40 million from real estate owned (REO) operations, compared with expenses of $159 million in the prior quarter and $9 million in the prior year quarter.

Net worth deficit of $1.7 billion as of Jun 30, 2010 was lower than a deficit of $10.5 billion as of Mar 31, 2010. The net worth deficit was primarily driven by a total comprehensive loss attributable to Freddie Mac of $0.4 billion and a dividend payment of $1.3 billion to the Treasury on its senior preferred stock.

Credit Metrics

Credit quality remained mixed during the quarter. Total single-family delinquency rate, excluding structured transactions decreased 17 bps sequentially to 3.96%.

Net charge-offs increased to $3.9 billion from $2.8 billion in the prior quarter and $1.9 billion in the year-ago quarter, driven primarily by REO acquisitions, higher volumes of short sales and other foreclosure alternatives.

Total nonperforming assets increased to $118.7 billion as of Jun 30, 2010 from $116.1 billion as of Mar 31, 2010 and $75.6 billion as of Jun 30, 2009. The sequential increase was mainly attributable to continued weakness in the housing market.

During the reported quarter, provision for credit losses was $5.0 billion, compared with $5.4 billion in the prior quarter and $5.6 billion in the year-ago quarter.

Business Update

Freddie Mac mainly focuses on initiatives that support the Making Home Affordable Program (MHA Program) announced by the Obama Administration in February 2009. As a leading player, Freddie Mac continued to support the housing market during the quarter.

In the reported quarter, Freddie Mac helped more than 350,000 borrowers stay in their homes and provided permanent foreclosure alternatives for 82,260 struggling borrowers through the company's long-standing traditional foreclosure avoidance programs and Home Affordable Modification Program (HAMP). Additionally, 61,821 loans remained in HAMP trial periods as of Jun 30, 2010, according to information provided by the MHA program administrator.

Our Take

We anticipate losses of Freddie Mac to increase in the coming quarters and the conservatorship to continue for a long time, and thus see no value for the common shareholders. However, we foresee the company’s increased participation in the MHA Program, potentially reducing losses from foreclosures in the upcoming quarters. We think the deterioration in the overall market condition will continue to negatively impact Freddie Mac’s financial results.

As a result of the net worth deficit, Federal Housing Finance Agency (FHFA), as Conservator, will submit a request for $1.8 billion in additional funding to Treasury under the terms of the Senior Preferred Stock Purchase Agreement.

However, considering the fundamentals, we are maintaining our long-term Neutral recommendation on the stock.