The Fannie Mae board of directors is scheduled to meet tomorrow to consider the future of two top executives, Franklin D. Raines and J. Timothy Howard, who had defended accounting practices that were rejected this week by the Securities and Exchange Commission staff.
The executives, who had been hoping the SEC would back them up in the face of criticism from other regulators, were stunned when the SEC's top accountant directed the company to correct past financial reports, a source close to the company said.
Raines, the company's chairman and chief executive, and Howard, the chief financial officer, did not respond to requests for interviews, and company spokesmen had no comment on the management situation yesterday.
Regulators at the Office of Federal Housing Enterprise Oversight, which has accused Fannie of cooking its books, were considering steps to oust the two executives if they didn't resign or the board didn't fire them, sources said.
Another major challenge the board must address is shoring up the giant mortgage-funding company's reserves as it prepares to book losses of $9 billion or more that it improperly excluded from earnings since 2001. The correction will leave Fannie, which is allowed to operate with a thinner financial cushion than banks, below its capital requirement.
"The Fannie Mae board is working diligently on all issues, and OFHEO is working closely with them," Corinne Russell, spokeswoman for the agency, said yesterday.
The company's stock closed yesterday at $70.31, up $1.01, as investors maintained equanimity in the aftermath of the SEC's decision. The stock market value of the company tumbled by about $14 billion after OFHEO's allegations were aired in September, but it has since regained about half of that ground.
Chartered by the government to promote homeownership, Fannie borrows money by issuing bonds and uses that money to buy mortgages from lenders, giving them funds to extend more loans. It also packages mortgages into securities that can be sold to investors, along with Fannie's guarantee that it will pay investors the principal and interest they are owed if the borrowers default.
As of October, it held $913 billion in mortgages and mortgage-backed securities, out of a total U.S. mortgage market of $7.8 trillion.
In a research report, analyst Michael McMahon of Sandler O'Neill & Partners LP estimated that Fannie will need to raise about $13.4 billion of capital to compensate for the $9 billion correction and fulfill an earlier agreement with regulators to boost its reserves. Fannie's expected earnings through the first quarter of next year could cover $5.5 billion of the shortfall, McMahon estimated, leaving a gap of $8 billion.
One way to cover the shortfall would be to reduce its mortgage holdings by $320 billion, but that approach "would likely needlessly disrupt the mortgage market," McMahon wrote. The analyst, whose firm has served as investment banker to Fannie Mae, predicted that regulators would allow Fannie to come into compliance more gradually.
"While these improper decisions do not threaten the financial soundness of the corporation, and should not be used by anyone in an effort to cut back on Fannie Mae's housing efforts, they do reveal troubling deficiencies in its corporate governance," Rep. Barney Frank of Massachusetts, senior Democrat on the House Financial Services Committee and a longtime supporter of the company, said in a news release Thursday.