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Fannie Mae Plans $5 Billion Stock Sale

Move Designed to Increase Capital Level

By Terence O'Hara
Washington Post Staff Writer
Thursday, December 30, 2004; Page E01

Fannie Mae, moving to shore up its capital, said yesterday it will sell $5 billion in preferred stock in a private placement to large investors.

The preferred stock sale, the single largest amount of equity capital ever raised by the company, would cure Fannie's immediate problem of being "significantly under-capitalized" for regulatory purposes, a designation given to Fannie last week after the Securities and Exchange Commission's chief accountant told the company to restate its financial results, effectively wiping out $9 billion in capital.

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On its own, however, the preferred stock sale would not increase capital enough to achieve a 30 percent surplus over Fannie's required minimum capital level. The Office of Federal Housing Enterprise Oversight, Fannie's regulator, ordered the higher capital levels in September because of what it said were accounting problems and internal control weaknesses.

OFHEO spokeswoman Corinne Russell said the $5 billion preferred stock sale is part of a capital enhancement plan that Fannie will submit to the agency soon.

"This will get them above the regulatory minimum," said Edwin Groshans, head of mortgage finance at New York investment bank Fox-Pitt, Kelton. "But they still have a capital shortfall they will have to cure."

OFHEO is working closely with Fannie director Donald B. Marron, a former investment banking executive who is overseeing Fannie's capital-raising efforts. Besides the preferred stock sale, Fannie can increase its capital by selling off some of the mortgage assets that make up the bulk of its holdings.

"This placement of preferred stock is a key component of Fannie Mae's capital restoration plan," Marron said in a statement. "We will be finalizing the details of the capital plan shortly."

The sale will more than double the preferred stock component of Fannie's capital base. Of Fannie's total $26.1 billion in stockholder equity on June 30, $4.1 billion was attributable to existing preferred stock. Preferred stock is a class of stock senior to common stock and typically pays a dividend at a specified rate regardless of whether common stockholders are paid a dividend. Preferred stockholders generally do not have voting rights.

One of the key features of Fannie's common stock has been its set quarterly dividend, currently 52 cents a share. Some analysts have worried that OFHEO could order a halt to Fannie's common stock dividend to preserve the company's capital.

Groshans said the preferred stock sale means "the likelihood of keeping the dividend on the common stock is enhanced."

Fannie chose to issue the preferred stock through what is known as a "144a" offering, in which only sophisticated institutions or wealthy investors are allowed to buy the stock. Such offerings are exempt from the time-consuming and costly process of registering the shares with the Securities and Exchange Commission, in which the terms and potential risks to ordinary investors are outlined in great detail in a formal prospectus. A 144a offering has the benefit of speed, allowing Fannie to show its regulator and the public that it has ready access to capital.

In a 144a, investors would probably include large mutual fund companies, banks, pension funds, large endowment funds or other institutional investors.

Groshans said a 144a offering this large is unusual but not unheard of. Fannie has good relationships with all the big Wall Street investment banks, and there will be no shortage of buyers, he predicted. According to Bloomberg data, Fannie's sale will be the largest single preferred stock sale in three years.

Fannie Mae said the offering includes two types of preferred stock. A $2.5 billion issue will have a 5.375 percent dividend rate and be convertible into common stock at a price of $94.31 per common share, about $24 more than yesterday's closing price. The other $2.5 billion will be nonconvertible. The dividend rate on the nonconvertible preferred stock will re-price quarterly, linked to a common U.S. Treasury rate index, but the rate will never be less than 7 percent.

New York investment bank Lehman Brothers Inc. is managing the stock sale, which is expected to close today.

Fannie's most recent nonconvertible preferred stock issuance, in September 2003, had a 5.5 percent dividend rate. Groshans said the company needs to offer higher dividends to attract buyers in the face of its regulatory scrutiny and its immediate need to raise capital.

Fannie, which provides cash to the home mortgage market by buying mortgages from lenders, ousted its top two executives, including chief executive Franklin D. Raines, as a result of the accounting problems. Its stock closed yesterday at $70.38, up 54 cents.

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