Wednesday, August 13, 2008

Fannie Posts Deep Loss

Fannie Mae reported a wider-than-expected second-quarter loss of $2.3 billion and said it expects more heavy losses from the surge in home-mortgage defaults.

Mounting losses at both Fannie and Freddie Mac, the two main providers of money for home mortgages, are limiting their ability to buy and guarantee home loans. That may mean higher interest costs for consumers.

CONFERENCE CALL Fannie Posts Deep Loss"What are losses going to be? Where is credit going to go? Where are home prices going to bottom? How long is that going to last? What's the overall impact of the macroeconomy? What is funding liquidity in the capital markets? All of these scenarios that everybody has are highly, highly sensitive to the variables and the assumptions that you make. And none, in my view, are conclusory enough to have full visibility into where they wind up in '09" -- Dan Mudd, Fannie president and CEO.Read the full transcript of Fannie Mae's conference call, provided by Thomson StreetEvents (www.streetevents.com). (Adobe Acrobat Required.)

"Mortgage rates can easily go as much as 0.25 percentage point higher this fall, even if general interest rates remain stable or drop," said Jim Vogel, an analyst at FTN Financial Capital Markets. Rates on 30-year fixed-rate mortgages averaged 6.64% over the past week, according to HSH Associates, a financial publisher.

Fannie chopped its quarterly dividend to five cents per common share from 35 cents but said it still may need to raise more capital, beyond the $7.4 billion in proceeds from share offerings in May. Congress last month gave the Treasury authority to make loans to Fannie or Freddie or buy shares in them, and some analysts say they think the Treasury eventually will have to shore the pair up by acquiring sizable equity stakes.

Fannie's report came two days after Freddie recorded an $821 million second-quarter loss. During the past four quarters, Fannie and Freddie have posted combined losses of about $14 billion, eating deeply into their relatively meager capital holdings.

Fannie's second-quarter loss amounted to $2.54 per common share, nearly four times the consensus forecast of analysts surveyed by Thomson Reuters. Net income was $1.95 billion, or $1.86 a share, in the period a year earlier.

Shares of Fannie Mae fell 90 cents, or 9.1%, to $9.05 as of 4 p.m. in New York Stock Exchange composite trading.

Separately, Dodge & Cox, a fund management firm in San Francisco, disclosed in a securities filing that it owns about 120 million Fannie shares -- or 12% of the total -- up from 1.2% at the end of March. A Dodge spokesman declined to comment.

Losses are turning out worse than generally forecast largely because home prices have fallen more steeply than expected, particularly in such states as California, Florida, Arizona and Nevada, Fannie executives said on a conference call with investors. That means Fannie and Freddie recoup less money from sales of foreclosed homes. Prices for single-family, detached homes in July were down 28% from a year earlier in California and down 17% in Florida, according to data to be released Monday by First American LoanPerformance. For the U.S. as a whole, the decline was 11%.

"The housing market has returned to Earth fast and hard," Fannie Chief Executive Daniel Mudd said on the conference call. He said Fannie's capital should remain above its regulatory minimums this year, but the company has "less visibility" about whether it will need to raise more for 2009. That depends partly on how far house prices fall, as well as the effects of rising unemployment and energy costs on Americans' ability to make mortgage payments.

One big worry is that the market has deteriorated further since the end of the second quarter, reducing the value of Fannie's and Freddie's mortgage holdings, said Frederick Cannon, chief equity strategist at Keefe, Bruyette & Woods.

The two companies acquire home loans from lenders and package them into securities. They keep some of those securities and sell the rest to other investors, earning fees for guaranteeing payments on those securities. When people default on their home loans, Fannie and Freddie have to compensate the holders of the mortgage securities. The two own or guarantee more than $5 trillion of U.S. home mortgages, or nearly half the total outstanding.

Another concern is that Fannie and Freddie are masking some of their exposure by rushing to ease terms for more delinquent borrowers and taking other steps to prevent foreclosures. In some cases, that just delays the pain. Fannie disclosed that as of June 30 it had financed 17,901 unsecured loans, totaling $127 million, to distressed borrowers to help them catch up on overdue mortgage payments.

Ajay Rajadhyaksha, head of U.S. bond market research at Barclays Capital, said he believes it is "very likely" that the Treasury will buy preferred stock in both Fannie and Freddie to try to restore investor confidence in them, perhaps within the next few weeks. "The longer they wait, the more it could cost them in terms of the money they have to put in," he said.

The main cause of the loss in the latest quarter was an increase of $3.7 billion in provisions for default losses, bringing the loss reserve to $8.9 billion. Fannie also took a $507 million charge to reflect the drop in values of securities backed by subprime and Alt-A mortgages. Alt-A is a category between prime and subprime and typically involves loans for borrowers who weren't required to fully document their income or assets, often leading to fraud. Critics call these mortgages "liar loans."

Alt-A loans, which represented about 11% of the $2.7 trillion of single-family mortgages owned or guaranteed by Fannie as of June 30, accounted for about half of the company's credit losses in the second quarter.

Fannie said it has tightened up requirements for such loans already and will stop buying them by year end. Eager to regain market share from Wall Street rivals, both Fannie and Freddie loaded up on Alt-A loans just as the housing market was crumbling in 2006 and 2007.

Fannie Posts Deep Loss

Write to James R. Hagerty at bob.hagerty@wsj.com and Aparajita Saha-Bubna at Aparajita.Saha-Bubna@dowjones.com



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