AP
Fannie Mae Posts Nearly $3.6B Loss in 4Q
Wednesday February 27, 6:53 pm ET
By Marcy Gordon, AP Business Writer
Federal Regulator Lifts Limits on Mortgage Portfolios Held by Fannie Mae and Freddie Mac


WASHINGTON (AP) -- Fannie Mae and Freddie Mac will be allowed to expand their roles in the turbulent mortgage market even as worsening conditions in the housing sector punish the two companies.

Fannie, the largest buyer and backer of U.S. home loans, said Wednesday it lost nearly $3.6 billion in the fourth quarter of 2007 amid mounting home-loan delinquencies and soured bets on interest rates. Freddie is expected Thursday to report a $1.5 billion fourth-quarter loss, according to Wall Street estimates.

Under a previous agreement with federal regulators, the timely filing of Fannie's and Freddie's financial results triggers the removal of an investment-portfolio cap placed in the aftermath of multibillion-dollar accounting scandals at the government-sponsored companies.

Analysts said the impact will be limited, however, because of the large cash cushion Fannie and No. 2 mortgage financer Freddie must maintain as a reserve against risk. Tightness in credit markets makes it expensive for Fannie and Freddie to marshal additi/.onal funds.

Fannie, which gave a pessimistic housing outlook for 2008, said close to 90 percent of its fourth-quarter losses stemmed from investments it made based on the assumption that falling interest rates would cause mortgage values to appreciate.

Shares of Washington-based Fannie, the largest U.S. buyer and backer of home loans, swung widely after the report was released, initially falling by more than 5 percent and later rising by roughly 15 percent. Shares of Fannie climbed 30 cents, or 1.1 percent, to close at $27.27. Shares of Freddie fell 12 cents to $25.09.

Fannie's $3.56 billion quarterly loss more than doubled from a loss of $1.4 billion in the third quarter of 2007 and contrasts with a profit of $604 million in the same period a year earlier. The loss was equivalent to $3.80 a share, far steeper than the $1.24-per-share loss forecast by analysts surveyed by Thomson Financial.

"The housing conditions are serious and they've gotten worse," the company's president and CEO, Daniel Mudd, said in a conference call with analysts. "This is an extraordinarily uncertain market."

Mudd called 2008 "another tough year."

If current market conditions continue or worsen, the company said, it may have to raise new capital by selling off mortgage investments, mounting another sale of special stock or further reducing -- or even eliminating -- its dividend.

A silver lining for Fannie, executives said, will be the anticipated wave of refinancing activity as borrowers with adjustable loans resetting at higher rates secure more affordable, fixed-rate mortgages. Plans put in place by the Bush administration and Congress are intended to prime the mortgage-market pump, though the effects so far have been limited.

An additional spark to the mortgage market could come following Wednesday's announcement by the Office of Federal Housing Enterprise Oversight, which said that on March 1 it will remove the combined $1.5 trillion cap on Fannie's and Freddie's mortgage holdings.

However, a bigger constraint on the companies' ability to buy mortgages has been a government mandate that requires Fannie and Freddie to keep 30 percent more capital in reserve than the minimum legal requirement, analysts said. That restriction, which the government is considering decreasing gradually, means Fannie and Freddie would have to boost their reserves by billions more to be able to make more loan purchases.

"The question becomes do they have the capital to maintain a larger portfolio?" said Bert Ely, a banking consultant based in Alexandria, Va.

Because of the required 30 percent cushion, the companies have been forced to sell special stock to raise a total $13 billion in capital in 2007 and have cut dividends.

"Our No. 1 priority is capital," Mudd said in the conference call.

Sen. Charles Schumer, D-N.Y. called the decision to eliminate the portfolio limits "long overdue" and also said the capital requirement should be lifted immediately.

The government "clearly is responding to pressure to open up Fannie and Freddie's ability to buy loans," said Bob Walters, chief economist with Quicken Loans, a mortgage company based in Livonia, Mich.

Fannie attributed $3.2 billion of its losses to the revaluing of complex financial instruments it uses to hedge against swings in interest rates.

Through these investments, known as "interest rate swaps," Fannie tries to hedge against the risks of rising or falling interest rates. The mortgages on the company's books tend to rise in value when interest rates drop, and vice versa. But that bet hasn't worked out of late, as interest rates fell in the fourth quarter and the value of mortgages held on the company's books has fallen as well.

Fannie said Wednesday it expects U.S. home prices to fall by 5 percent to 7 percent this year. It earlier forecast a decline of 4 percent to 5 percent. Fannie Mae said it expects to lose money this year on 11 to 15 of every 1,000 mortgages held on its $2.4 trillion book, up from its earlier expectation of eight to 10 and a steep increase from four to six in 2007.