Fannie Shares Tumble as Home Loan Defaults Rise

Fannie Mae posted a much larger-than-expected second-quarter loss and slashed its dividend more than 85 percent to preserve capital as home loan defaults accelerated in the bleakest U.S. housing market since the Great Depression.

CNBC.com

Three weeks after U.S. authorities took sweeping steps to support Fannie Mae and its smaller sibling Freddie Mac , the two largest providers of U.S. home mortgage funding, Fannie said its credit costs will keep rising this year.

Fannie Mae Chief Executive Daniel Mudd said the company would likely boost reserves, but said it had not taken advantage of assistance recently made available by the U.S. Treasury and Federal Reserve Bank.

Fannie also said it will cease buying certain risky mortgages that accounted for nearly half of its credit losses in the quarter and set a year-end target for doing so.

Fannie Mae, whose shares dropped more than 6 percent following the earnings news, said its loss totaled $2.3 billion before preferred dividend payments, or $2.54 per share.

It was Fannie Mae's fourth straight quarter of red ink, bringing its cumulative loss over the last 12 months to $9.44 billion before preferred dividends.

The loss reversed a profit of $1.95 billion, excluding preferred dividend payments, from a year earlier. Excluding extraordinary items, the second-quarter loss equaled $2.51 per share, more than two-and-a-half times greater than the average estimate among Wall Street analysts of 98 cents per share, according to Reuters Estimates.

"The key for Fannie and Freddie both, and also for banks, is 'Do they have the capital to get through the next year or so?"' said David Dreman, chairman of Jersey City, New Jersey-based Dreman Value Management, a large holder of Fannie and Freddie Mac shares.

"Their revenues are up pretty significantly," he added. "So if they can hold, if they are not taken under by a wave of defaults now, it'll be a good business two years out. It looks like they can, but there are a lot of negatives out there too."

The steep second-quarter loss included $5.3 billion in credit expenses stemming from the worst housing market since the Great Depression and follows a loss of $2.51 billion, or $2.57 per share before preferred dividend payments, in the first quarter of 2008.

Mudd told a conference call the company anticipates increasing its loss reserves.

"The housing crisis that we all observe as we drive home every single day continues to strain our results and our capital," he said.

By year's end, Fannie Mae will stop buying Alt-A mortgages, riskier mortgages that require less proof of borrower income. These loans made up about 11 percent of the company's total single-family mortgage credit business, but spurred about half of its credit losses in the second quarter.

Fannie said it has already reduced its holdings and purchases of Alt-A mortgages by 80 percent from peak levels. Far fewer such loans are being originated under tighter lending standards imposed as a result of the subprime lending crisis.

Shoring Up Capital

Fannie Mae and Freddie Mac own or guarantee more than $5 trillion in mortgages, or nearly half of all U.S. home loans.

Fannie Mae raised forecasts of future credit losses, as it sees home prices falling through the year.

It now appears the house price drop will be at the upper end of the company's 15 percent to 19 percent peak-to-trough estimate, Fannie said.

The company maintains it will stay above its regulatory capital requirements through 2008, although volatile markets leave it "less visibility" into its 2009 capital position.

Its $47 billion in core capital as of June 30 was $14.3 billion above its statutory minimum capital requirement and $9.4 billion over its 15 percent surplus requirement.

Fannie Mae said "while we expect that 2008 will be our peak year for credit-related expenses, the total amount of credit-related expenses will be significant in 2009." These expenses more than offset rising revenues in the second quarter.

Fannie said it "may, from time to time, raise capital opportunistically" after raising more than $7 billion in added capital in the second quarter.

Fears that slumping home prices and record foreclosures had eaten away capital at Fannie Mae and Freddie Mac swept their shares to 17-year lows last month.

The swift share erosion came as the government relied more heavily on the two companies to buy mortgages, helping free up money for more lending and restore order to turbulent markets.

U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke arranged for emergency measures, signed into law last week by President Bush, to broaden government backing for Fannie Mae and Freddie Mac.

"None of the plans that we've advanced contemplate access to any Treasury line. We've not asked them and they have not offered," Mudd said on the call.

In Friday midday trading, Fannie Mae shares dropped 8.6 percent to $9.09 on the New York Stock Exchange, while Freddie Mac rose 1.2 percent to $5.96.

The cost to insure $10 million of Fannie Mae debt against a default for five years rose to 49.8 basis points in the credit default swaps market, or $49,800, from $48,550 on Thursday.

Fannie Mae's results come just two days after Freddie Mac also disappointed investors with a steeper-than-expected loss of $821 million. Like Fannie, Freddie also said it would slash its dividend and shore up its capital.

New York money manager Vontobel Asset Management Inc in recent weeks sold its remaining shares of Fannie and Freddie, ending a multiyear period of paring those holdings from as much as 7.5 percent of its assets, Ed Walczak, a portfolio manager, told Reuters.

Vontobel as recently as July held about 1 percent of its holdings in the two companies.

"I don't think it's by any means inevitable that they will go insolvent. But after the legislation, we don't know what the capital will be," he said. "We are no longer investors in Fannie Mae and Freddie Mac."

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