By Thomas Heath and David S. Hilzenrath
Washington Post Staff Writers
Saturday, November 17, 2007
Shares of Fannie Mae experienced their steepest two-day drop in 20 years after concerns grew among investors that the home mortgage giant changed its financial disclosures in a way that could mask credit losses.
The stock fell 5.5 percent yesterday, or $2.35, to close at $40.69. It plunged 10 percent Thursday.
An online report this week by Fortune magazine questioned the way the District company reported certain information related to foreclosures. At issue was a measure called the credit-loss ratio, a key indicator of the company's financial health. Fannie Mae uses the ratio to compare losses related to delinquencies and foreclosures with the overall scale of its mortgage business.
Company executives yesterday said the ratio does not include accounting charges for unrealized losses on certain troubled loans -- losses that have not been locked in. If those unrealized losses were included, the credit-loss ratios for the third quarter and first nine months of this year would have been larger than what the company disclosed.
Fannie Mae spokesman Brian Faith said the company did not change its accounting but altered the way the information is presented in documents it files with the Securities and Exchange Commission.
That component may have confused investors, the Fortune report said.
"We did not mislead investors," Faith said. "This was done to provide greater transparency."
Fannie Mae's chief financial officer, Stephen M. Swad, said the unrealized losses, based on the amount a third party would pay for the loans, may never come to pass. But during the fiscal quarter that ended Sept. 30, amid significant disruptions in the mortgage market, the unrealized losses rose to a level "well above" the company's expectations of actual losses, Swad said.
Analysts were divided on whether Fannie Mae was being less than clear in its disclosures.
Eric E. Wasserstrom with UBS investment research wrote that Fannie Mae's phone conference yesterday "has created ambiguity regarding next year's provision expense" for credit losses.
Karen Shaw Petrou, managing partner of Federal Financial Analytics, a past critic of Fannie Mae's bookkeeping, said she did not think the company was trying to play accounting games. "We've seen a bunch of things they did in the past . . . and hopped up and down" but not this time, she said.
Petrou said investors are being "overly panicked" about mortgage-related losses. Big Wall Street investment banks have announced a spate of multibillion-dollar write-offs in recent weeks. Fannie Mae reported last week that its third-quarter loss more than doubled, to $1.39 billion, as the wheezing housing market pushed up delinquencies.
"Wall Street is fear and greed, and this is fear," Petrou said. "Nobody wants to be the last out the door, and that's a piece of what's going on here."
Fannie Mae owns or guarantees about one-fifth of the $11.5 trillion U.S. residential mortgage market.
Congress created Fannie Mae and its competitor, Freddie Mac, to increase mortgage financing by buying loans from lenders. The companies profit by holding mortgages and mortgage bonds as investments and by charging fees to guarantee and package loans as securities.
The company has been under a cloud since 2004, when regulators accused it of improper accounting that ultimately led to a $6.3 billion reduction in previously reported profits and the retirement of chairman and chief executive Franklin D. Raines. The company agreed to limits on the size of its investment portfolio until it cleaned up its accounting problems and returned to timely financial reporting.
Fannie's stock price soared over the summer on expectations that it could parlay the meltdown in the mortgage markets into big financial gains by persuading the government to ease restraints on the volume and size of mortgages it can purchase.
Instead, Fannie Mae and its competitor Freddie Mac now find themselves constrained by the need to maintain required levels of capital to cushion against financial reversals, as the value of some mortgage-related holdings declines, and its losses from loan defaults and foreclosures have been rising.
The conference call fueled concerns that current reserves don't reflect future needs. Fannie Mae told analysts that, under accounting rules, it must reserve based on current conditions, not expected conditions in a worsening market.
Staff researcher Richard Drezen contributed to this report.
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