Fannie Mae Reports $3.56 Billion Loss

By David S. Hilzenrath
Washington Post Staff writer
Thursday, February 28, 2008

Fannie Mae, a titan of the mortgage business, yesterday reported that rising defaults and falling home prices contributed to a $3.56 billion loss in the last three months of 2007.

The company predicted that housing prices will continue to fall and that its financial performance will get markedly worse. "The housing conditions are serious and they've gotten worse since our last projection in November," chief executive Daniel H. Mudd said in a conference call with investors. "The overall economic outlook has dimmed, credit is tighter, home sales have stalled as buyers wait for prices to bottom out . . . and prices have fallen quickly in a number of states."

Fannie Mae's stock price rose early in the day after a federal regulatory agency announced that it would remove caps on investments by the company and its competitor Freddie Mac. But the rally largely evaporated by the end of the day as investors concluded that Fannie Mae may no longer be in a strong enough position to take advantage of the regulatory relief it had long sought.

Fannie Mae's $3.56 billion loss ($3.80 a share) in the fourth quarter compared with a profit of $604 million (49 cents) in the fourth quarter of 2006. The downward trend in the second half of the year helped drive Fannie Mae's loss for all of 2007 to $2.05 billion ($2.63), compared with a profit of $4.06 billion ($3.65) for 2006.

Fannie Mae now expects average peak-to-trough declines in home prices of 13 to 17 percent before the market recovers, compared with its earlier predictions of 10 to 12 percent.

Fannie Mae's annual results included $160 million of write-downs in the value of securities backed by subprime mortgages. Not reflected, however, were $3.3 billion in unrealized losses on securities backed by subprime mortgages and other unconventional loans. Fannie Mae said it had not yet recorded losses on those investments because it thinks they will recover their lost value.

Chartered by the government to promote the availability of home loans, District-based Fannie Mae and McLean-based Freddie Mac play major roles in the nation's housing system. They pool mortgages into securities for sale to investors, promising to pay the principal and interest if the borrowers default. They also buy mortgages and securities backed by mortgages for their own investment portfolios.

The 2007 annual report was the first Fannie Mae had issued on time since an accounting scandal in 2004. In the years since, the company has rebuilt its financial systems and reported that it had overstated profits by $6.3 billion. With the filing of the report yesterday, Fannie Mae declared its rebuilding complete.

Freddie Mac, which disclosed billions of dollars of accounting problems in 2003, has been through a similarly protracted recovery and is scheduled to issue its 2007 annual results today.

In light of those accomplishments, the Office of Federal Housing Enterprise Oversight said yesterday that it will remove limits on the two companies' investment portfolios, effective Saturday. The limits were imposed after the accounting scandals.

Though Fannie Mae spent much of last year arguing that OFHEO should lift the limit on its investments and thereby liberate it to better help an ailing market, shedding the limit now comes as a somewhat hollow victory. With financial troubles continuing, a more important constraint on the companies' business is the amount of capital they must maintain as a cushion against losses, OFHEO Director James B. Lockhart has said.

Fannie Mae and Freddie Mac have operated under heightened capital requirements since 2004. Lockhart said in a written statement yesterday that his agency will talk to the companies about "the gradual decreasing" of that requirement, but he cautioned that he would take into account a variety of factors, including the companies' finances, broader market conditions and "the importance of the Enterprises remaining soundly capitalized."

In recent Senate testimony, Lockhart said he would be "much more comfortable" easing the capital requirement if Congress passed long-stalled legislation to give his agency more regulatory power.

The capital requirement is shaping up as the focus of a new battle over the government-chartered companies. Losses like those Fannie Mae reported yesterday bolster OFHEO's rationale for requiring extra capital, but weakness in the housing market adds pressure for the regulator to let Fannie Mae and Freddie Mac do more.

Douglas A. Dachille, chief executive of First Principles Capital Management, said neither lifting the portfolio caps nor easing the capital requirement would make much difference to borrowers. In a memo to a client, he compared those steps to "handing out air freshener to homeowners who live next to a landfill."

In a report to clients, Morgan Stanley stock analysts said the risk of a capital shortfall at Fannie Mae is greater than it previously appeared.

Mudd said that he foresees no need to raise more capital. Protecting Fannie Mae's current capital is the company's top priority, he said.

He acknowledged that responding to the kind of crisis that now grips the housing market "is something we were chartered to do," but he said that was a lower priority.

As part of its effort to conserve capital, Fannie Mae is shifting its emphasis from investing in mortgages directly to the less capital-intensive business of guaranteeing them for other investors. One silver lining for Fannie Mae, if not for lenders and borrowers, is that the company is raising the fees it charges to guarantee loans, effective next month.

Fannie Mae shares rose 30 cents yesterday, to $27.27, far off their high for the past year of $70.57.

Staff researcher Richard Drezen contributed to this report.