How Freddie Mac’s Reverse Stock Split Works

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The troubled GSE has another way to keep its head above water. Freddie Mac is on life-support system. At the onslaught of the property crisis last September, the government has taken control over the agency’s activities when it fell under conservatorship along with Fannie Mae. Under this arrangement, the two government sponsored enterprises (GSEs) have been infused with $100 billion each but 80 percent of each firm’s stake will be under government control. Diving Share Prices At the start of the year, Freddie Mac’s shares showed minor fluctuations between $30 and $40. By March, the share price plunged below $20 only to take a modest recovery above $30 in the middle of the month. Then the property sector was already in the doldrums the following weeks and things all went downhill from then on. The months of June and July saw the steepest plummeting of share prices falling down below $10. Last Tuesday, share price closed at 77 cents. The New York Stock Exchange requires companies to maintain stock prices above $1. Trading below such price would mean delisting from the exchange under listing requirements. What this means is that Freddie Mac may not still be bankrupt but it will have to trade over-the-counter or in the pink sheets system where there is less regulation but are highly susceptible to downturns. Furthermore, if the company remains in either trading markets, investor confidence will fall and institutional investors (ex. pension funds and insurance companies) would be able to offer less information on the quality of the stock. Freddie Mac would then have lower trading volumes and be on the line for bankruptcy. But the federal government wouldn’t allow that to happen to the country’s largest mortgage firm. Last Tuesday, Freddie Mac told NYSE that it has no choice but to resort to reverse stock split to keep share prices above $1. A reverse stock split is commonly taken by companies with a notice of delisting to raise the par value of the stock or its earnings per share. It’s a legal, artificial way of raising the price since the market capitalization remains the same. If for example the 54,658,961 FME shares are split in a 1-for-10 scheme, the investor would own only one share for every 10 shares that he originally possesses. If the price is currently at 77 cents, the new price of the “one” stock will now be $7.70 (77 cents times 10 shares). Notice that by reducing the number of shares, the par value has increased but Freddie Mac’s $498.31-million capitalization remains the same. Such move would save hundreds of investors from further losing their confidence in the troubled mortgage agency. Visit blog for more helpful articles!

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