Fannie Mae Agrees to Accounting Changes

Fannie Mae chief executive Franklin D. Raines appeared before the Senate Banking Committee in February. (Dennis Cook -- AP)

Investors reacted positively to the agreement yesterday, sending Fannie Mae's stock up 99 cents, or 1.5 percent, to $66.50. Last week, investors drove Fannie's stock down 15.2 percent to a 52-week low of $65.51.

Michael Yarian, senior government agency bond trader at Barclays Capital in New York, said the bond market's initial concerns over Fannie's future appear to have eased. "There is no sense of impending doom in the market," Yarian said. "Fannie Mae has been very above board and gone out of their way to cooperate" with regulators. "No one believes that Fannie is going into any sort of liquidity crisis."

Some Wall Street stock analysts were less positive, however. Prudential Equity Group LLC downgraded Fannie's stock to a "neutral" rating, saying the requirement that Fannie set aside more capital could slow the firm's growth. Morgan Stanley downgraded Fannie from "overweight" to "equal weight."

One of the key elements of the agreement calls for Fannie to increase the amount of capital it keeps on hand within nine months to 30 percent more than the minimum it has been required to maintain. As of March 31, Fannie was required to hold $31.354 billion of capital, which it exceeded by $4.347 billion, or 13.9 percent, OFHEO reported. Based on the March numbers, Fannie would have to increase its capital by about $5.1 billion.

Correcting Fannie's derivatives accounting for past years could alter reported earnings by billions of dollars, the OFHEO report said.

Wall Street analysts who follow Fannie Mae said they did not believe the firm would have trouble raising the capital. To do so, Fannie Mae could issue new stock, reduce its dividend, sell current assets from its portfolio of mortgages, or slow growth by reducing the rate at which it purchases mortgages from lenders.

Several analysts said Fannie Mae would probably choose to sell assets or reduce growth, in part because selling stock would require the firm to warn investors that its current financial statements are under review and may have to be restated. Issuing more stock could also further harm Fannie's share price.

Standard & Poor's analyst Michael T. DeStefano said in an interview that Fannie Mae could also reduce the amount of stock it buys back from investors. "Their financial flexibility is very strong," he said. "This is a very manageable thing for them to achieve."

Regulators began a special review of Fannie's accounting late last year after an investigation of Freddie Mac concluded that Freddie had used elaborate maneuvers to circumvent accounting rules and make its earnings appear smoother than they really were. The scandal at Freddie cost several top executives their jobs, including two chief executives forced out in rapid succession.

Since the disclosures about Freddie Mac, Raines had assured investors that Fannie Mae followed accounting rules.

But OFHEO's examination concluded otherwise. In 1998, regulators allege, Fannie improperly postponed booking $200 million of expenses, enabling Raines and other top executives to receive millions of dollars of bonuses that were pegged to the company's financial performance.