Fannie Mae, the government-sponsored housing finance company, reported a 0.9 percent increase in earnings during the second quarter. The company, based in the District, said it earned $1.112 billion ($1.10 per share), up $10.3 million from $1.102 billion ($1.09) in the same quarter a year earlier.

Fannie reported an 11.1 percent decline in one of its major profit sources, interest earned on its $891.2 billion portfolio of mortgages.

In the second quarter of 2003, the company's earnings were dragged down by $739.8 million of losses from the repurchase and redemption of its own debt. In the second quarter of 2004, those activities generated $23.5 million of pretax gains.

Fannie Mae serves as a middleman between investors and mortgage lenders. It charges lenders fees to repackage mortgages into securities for sale to investors. In addition, it borrows money, which it uses to invest in mortgages, profiting from any difference between the interest it pays to borrow and the interest it receives from the mortgages it holds.

Under accounting rules, Fannie's earnings can be whipsawed by changes in the value of complex financial contracts it uses to hedge against changes in interest rates, even if those contracts remain on its books. In the second quarter, Fannie recorded almost $2 billion of unrealized losses on these "derivatives," up from about $1.9 billion of such losses.

Fannie showed rising earnings during the second quarter partly because it reduced the amount of money it was holding in reserve against potential losses from mortgage defaults. Citing "extremely low losses" so far this year, the company said it reduced the reserve by $38 million, which boosted pretax earnings by that amount.

Fannie Mae spokeswoman Janis Smith said that given the level of credit losses Fannie was experiencing, reducing the reserve was not optional.

Fannie issued a cautionary word to investors yesterday, predicting that its core business earnings for the rest of this year will be lower than the company was projecting in the spring. Fannie's stock closed at $71.60 a share, down $2.68.

The company's earnings took a $278.2 million pretax hit as it wrote down the value of certain securities, including those related to mobile homes. Fannie's regulator, the Office of Federal Housing Enterprise Oversight, had forced the company to adopt a new method of accounting for declines in the value of those securities.