Freddie Mac net profit tumbles as defaults rise

WASHINGTON (Reuters) - Freddie Mac (NYSE: - ), the nation's second-largest source of home loan funding, said on Thursday its second-quarter net income fell 45 percent from a year earlier as more borrowers defaulted on their loans.

Freddie Mac buys mortgages that banks extend to the highest quality homeowners and the spike in failed loans indicates defaults are spreading well beyond the riskiest subprime borrowers. Its shares suffered their biggest one-day loss in four years.

The $764 million in net income fell sharply from the $1.4 billion last year.

The company's chief financial officer blamed a rise in mortgage defaults for the lower earnings. Costs related to current and future failed loans rocketed 433 percent from a year earlier to $336 million, and rose 74 percent from the first quarter.

Rising loan failures have not yet set off alarms about the quality of the company's assets, said Jim Vogel, who tracks the company for FTN Financial in Memphis, Tennessee.

"By historical standards, that is still a moderate loss but it's a fairly rapid increase from the first quarter," Vogel said.

Still, Freddie Mac's Chief Executive Richard Syron told a conference call that he was surprised by the extent of the housing downturn.

"I was bearish... but I was not bearish enough."

He added that the most severe predictions for a housing downturn are too harsh and he expects a recovery over the next 18 months.

Freddie Mac shares fell 5 percent to $60.09 while share of its mortgage finance cousin Fannie Mae (NYSE: - ) dropped 2.5 percent at $64.09. Freddie shares fell as much 5.3 percent in their steepest drop since June 2003, when an accounting probe spooked its investors.

Freddie Mac guarantees the payment stream for bonds created out of mortgages on its portfolio. Those mortgages have increasingly failed, leaving Freddie Mac with higher costs now and the need to set aside even more cash for the future losses.

Buddy Piszel, Freddie Mac CFO, said that Freddie has been buying back more failing loans in recent months and that the value of those mortgages have fallen.

Piszel said Freddie has "negligible" exposure to subprime loans and "the likelihood of us taking losses on that exposure are remote" because its assets are highly rated.

The company said consumers were returning to the traditional, fixed-rate mortgages that Freddie buys and securitizes. As a result, its business of guaranteeing home loans increased at an annualized rate of 15 percent in the second quarter compared to a 6 percent forecast of total U.S. mortgage debt this year.

In recent weeks, Fannie and Freddie have pushed for its regulator, the Office of Federal Housing Enterprise Oversight, to let it grow its mortgage holdings and add liquidity to the shaken market.

Officials from its OFHEO, the U.S. Treasury Department and the Federal Reserve have all said the companies' $1.4 trillion combined mortgage investment portfolio is dangerously bloated and should be frozen.

Fannie and Freddie are publicly-traded companies that hold federal charters to nurture the housing finance system.

OFHEO ordered Fannie and Freddie to freeze their mortgage holdings near their current level more than a year ago after accounting scandals shook both firms.