By David S. Hilzenrath
Washington Post Staff Writer
Saturday, August 9, 2008
Fannie Mae, a key source of support for the nation's struggling housing market, reported yesterday that its expenses from foreclosures and bad loans rose 64.9 percent during the second quarter and predicted deepening trouble ahead, heightening concerns that the federal government may have to come to the company's rescue.
The company said it is taking a variety of steps to avoid becoming undercapitalized as a result of further deterioration in the housing market, including cutting its third-quarter dividend to 5 cents per share, from 35 cents per share.
"The housing market has returned to earth hard and fast," chief executive Daniel H. Mudd said in conference call with analysts to discuss earnings.
Overall, Fannie Mae lost $2.3 billion ($2.54 per share) in the quarter ended June 30, more than triple what Wall Street analysts had expected and compared with a loss of $2.2 billion ($2.57) in the first quarter. In the second quarter last year, the company made a profit of $1.95 billion.
Fannie Mae's stock fell sharply on the earnings report, bucking a surge in other financial stocks to finish down 9 percent at $9.05.
Losses directly related to problems in the housing market were especially pronounced. The losses from foreclosures and other problem loans rose to $5.3 billion in the second quarter, from $3.2 billion in the first quarter. In July, the challenge grew even steeper, Mudd said.
A market that "many of us had already described as the worst in a generation took a turn for the worse after the quarter ended," he said, citing even higher defaults and sharper declines in home prices.
Along with rival Freddie Mac of McLean, the District-based company is one of the main sources of funding for mortgage lenders. The government has been depending on it to keep home prices from falling even more sharply. Fannie Mae's report followed a similarly grim report this week from Freddie Mac.
Fannie Mae packages mortgages into securities for sale to investors, promising to pay the investors if the borrowers default. It also buys securities backed by home loans. Its mortgage investments and guarantees total $3 trillion.
The meltdown of the housing market has taken a heavy toll on Fannie Mae and Freddie Mac, producing quarter after quarter of losses and wiping out most of the value of their stocks.
A panicked sell-off in shares of both companies last month prompted Congress and President Bush to adopt a rescue plan under which the Treasury can inject unlimited amounts of taxpayer money into the companies through loans or stock purchases, depending on their financial health.
Freddie Mac reported earlier this week that losses from failed loans nearly doubled during the second quarter, and it issued a significantly more pessimistic forecast for home price declines.
Paul J. Miller, an analyst with Friedman, Billings, Ramsey Group, said Fannie Mae's losses increase the likelihood that Treasury would use its new powers to help keep the company afloat. But added that he still doubts this will occur.
Over the coming months, Miller said, he expects even more worrying news for Fannie Mae and Freddie Mac. "To use a baseball metaphor," he said, "we're still in the third or fourth inning."
A key factor that may determine whether the government ends up bailing out either company is their level of capital, the financial cushion they are required to maintain to reduce the risk of insolvency.
Fannie Mae said that, based on internal projections, it is unclear whether the company can maintain the requisite capital through next year. Some of the company's projections indicated it could not.
After raising more than $7 billion of new capital during the second quarter, Fannie Mae said its $47 billion of capital as of June 30 exceeded the regulatory requirement by $9.4 billion. Many investors believe the requirement is much too low in relation to the multitrillion-dollar scale of the company's business.
Falling out of compliance with the capital requirement could trigger regulatory action to restrict Fannie Mae's operations.
To reduce the odds of that happening, Fannie Mae said it will cut annual operating costs 10 percent by the end of next year and increase the fees it charges to guarantee payments to investors in its mortgage-backed securities. The higher fees could be passed along to consumers, which could further stress the housing market.
The company said that by the end of this year, it will stop investing in new Alt-A loans, which have accounted for much of its losses. The term generally refers to loans issued on the basis of little or no proof of the borrower's income. Fannie Mae continued to invest in Alt-A loans even after the housing bubble burst.
"There is something here for every single constituency to dislike," Mudd said, referring to the raft of measures to conserve capital.
Fannie Mae said it will intensify efforts to recover some of its losses from lenders in which the lending decisions involved fraud or other improprieties. The company said it will also beef up its capacity to dispose of foreclosed homes.
To cover anticipated costs from bad loans, the company added $3.7 billion to its reserves in the second quarter, bringing them to $8.9 billion. Meanwhile, it wrote down by $507 million the value of investments in securities backed by subprime loans and other mortgages issued based on relaxed standards.
"The market remains extraordinarily challenging," Mudd said. "We're taking aggressive action to preserve capital and control our credit losses. Underneath that, the fundamentals of the business are strong."
Staff writer Jeffrey H. Birnbaum and staff researcher Madonna Lebling contributed to this report.
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