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Fannie Mae Confronts More Accounting Issues

Federal Regulators Questioning Company's Classification and Transfer of Securities

By Terence O'Hara
Washington Post Staff Writer
Thursday, February 24, 2005; Page E01

Fannie Mae said yesterday that its federal regulator has raised new accounting and internal control questions that could further damage the mortgage finance company's financial results and capital position.

In a lengthy release that also described company plans to slash its congressional lobbying budget and cut other costs, Fannie Mae said the Office of Federal Housing Enterprise Oversight is questioning several accounting methods that are central to how the company manages its $890 billion portfolio of mortgages and mortgage-backed securities.

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The issues cited by the regulator are in addition to deficiencies first disclosed in September that led to the resignation of Fannie's top two officers and forced the company to subtract up to $9 billion from previously stated earnings.

Among the new questions raised are whether Fannie Mae has been improperly classifying some of its securities as "held-to-maturity" when it really intends to sell them -- a strategy that would help insulate the company's balance sheet from short-term changes in market values. OFHEO is also questioning Fannie's transfer of some securities to separate "off-balance-sheet entities." The practice is often used by companies to free up capital, but OFHEO has asked whether in Fannie's case the transfers "serve a valid business purpose."

OFHEO had already ordered Fannie to significantly increase its capital reserves, and yesterday it approved the company's plan for doing so. Under the plan, Fannie's mortgage loan portfolio will shrink -- thus increasing the relative size of its capital cushion. The company has already raised an extra $5 billion through a preferred stock offering, and yesterday it announced cost reductions that include curtailing its lobbying budget. Fannie Mae paid its lobbying corps about $5 million in the first six months of last year.

The company said that "as a last resort," it would cut its stock dividend to preserve cash.

The company did not estimate the possible impact on its financial results should the newly highlighted accounting issues force it to further revise its financial statements. But a spokesman said Fannie Mae's strategy for raising its capital level will cover any unforeseen problems. In reviewing Fannie Mae's finances, OFHEO ordered the company to boost its capital reserves 30 percent beyond what federal regulations require.

"Fannie Mae's board and management believe that by tightly controlling balance sheet size, and applying additional retained earnings to capital, the company could exceed the surplus capital goal with a cushion for contingencies," said spokesman Charles V. Greener in a written statement. Greener declined to comment further. An OFHEO spokesman declined to comment.

The accounting errors disclosed last year -- centering on how Fannie Mae treated its use of complicated transactions known as derivatives -- could cause the company to reduce by $9 billion profit it claimed to have earned between 2001 and 2003, Fannie said in December.

Any restatement resulting from the most recent disclosures has to be approved by the Securities and Exchange Commission. The SEC's chief accountant has already ordered Fannie Mae to correct its accounting on derivatives.

Fannie Mae stock closed at $57.16 yesterday, down 64 cents.

District-based Fannie Mae buys home mortgages from lenders and guarantees repayment of securities backed by those mortgages. It issues bonds backed by mortgages and issues its own mortgage-backed securities to investors, ensuring a ready source of cash for lenders. Fannie and McLean-based Freddie Mac, both chartered by Congress, are the largest single buyers of home mortgages.

Rep. Richard H. Baker (R-La.), chairman of a House subcommittee overseeing Fannie Mae and Freddie Mac, said yesterday that he wasn't surprised by OFHEO's new criticisms. "It's unfortunate that additional disclosures have been made that reflect on management deficiencies," he said. "Although disappointing, the disclosure could add momentum to the need to consider a new regulatory system."

"The bigger issue is whether these are simply accounting disagreements or something more," said Matthew Park, who follows Fannie Mae for A.G. Edwards & Sons Inc., which owns Fannie Mae stock. "It's not surprising when someone is looking through your garbage that they would find something. . . . We already knew about the $9 billion. But what the impact of these are is unclear. It's going to take time to sort through."

Staff writer Ben White contributed to this report.

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