Regulator tells Fannie Mae to recalculate loan losses

Inquiry extends beyond bonds tied to aircraft leases, mobile homes


Fannie Mae, the giant housing finance company, has improperly accounted for some of the loans in its $1 trillion portfolio, a federal regulator said yesterday.

The Office of Federal Housing Enterprise Oversight, which regulates Fannie Mae, ordered the company to recalculate losses on those loans by May 14. The recalculation could force Fannie Mae to restate its profits downward, although the oversight office did not order that.

It is not yet clear how large a restatement Fannie Mae might have to make. The bonds under scrutiny include $8 billion in securities backed by mobile homes and $300 million backed by aircraft leases. Although the securities make up less than 1 percent of Fannie Mae's portfolio, they have become a focus for critics who say Fannie Mae hides losses and is riskier than it appears.

The order yesterday came in a letter from Armando Falcon, director of the oversight office, to Franklin D. Raines, chairman of Fannie Mae. In the letter, Falcon also said that the oversight office was continuing a broader inquiry into Fannie Mae's accounting.

In a statement, Fannie Mae said it would give the oversight office "the information required within the time frame requested," and said it was seeking guidance from the Securities and Exchange Commission.

With $1 trillion in assets at the end of 2003, Fannie Mae is the third-largest financial institution in the United States, behind Citigroup and Bank of America.

Fannie Mae and Freddie Mac, its corporate cousin, are government-sponsored companies that play a crucial role in the home mortgage market. They buy mortgages from banks and other lenders with money that they borrow from investors around the world. Most of their profits come from the difference in interest rates between the mortgages that they buy and the bonds they issue.

The loans under scrutiny by the oversight office are not regular home mortgages, but bonds backed by mobile homes and aircraft leases. Even if the company were forced to restate their value, the change is expected to have little effect on its overall financial position.

But the demand from Falcon adds to the political and business pressure on Fannie Mae, an unusual company that benefits from being closely associated with the federal government.

Fannie Mae has said that its accounting methods are proper. Both KPMG LLP, its auditor, and Ernst & Young LLP, an auditor retained by Fannie's outside counsel, say its accounting practices comply with accepted standards, the company said yesterday.

Since February, when the Federal Reserve and the White House stepped up criticism that Fannie Mae is too big and too risky to taxpayers and the financial system, Fannie Mae's stock has fallen 14 percent. Yesterday, its shares fell $1.27, or 1.8 percent, to $68.88. Freddie Mac's shares have dropped 10 percent during the same period.

Part of the drop is probably the result of rising interest rates, which generally hurt financial institutions. But Fannie and Freddie have fallen much more than big banks like Citibank over the period.

Because of their government charters, Fannie Mae and Freddie Mac have several advantages other companies do not. They are exempt from state taxes and have a small line of credit with the U.S. Treasury.

So, investors generally believe that the government would not allow Fannie and Freddie to fail if they ran into financial difficulty. The companies can borrow cheaper than almost any other private company. They have used that advantage to grow substantially over the past decade.

Some economists and politicians say that the companies are too big, making them particularly vulnerable to rapid changes in interest rates. The companies' critics also complain that compared with other big financial institutions, Fannie and Freddie do not have enough equity capital, the first cushion against losses in their portfolios.

Fannie Mae and Freddie Mac officials say they manage risk carefully and are adequately capitalized. Home mortgages are generally very safe investments, the companies say.

The loans at issue are not part of Fannie Mae's core mortgage portfolio, but part of a small group of higher-yielding investments. They are mainly bonds backed by mortgages on trailer homes, also known as manufactured housing.

But in the past several years, many buyers of mobile homes have defaulted on their loans.

Credit agencies have cut their ratings on many of the bonds, but Fannie Mae has been slower than some competitors to recognize losses on them.

The company says that its internal models show that the bonds are suffering only a temporary loss in value and that it does not need to write them down. But Lawrence Kam, a hedge fund manager who has sold the company's stock short, betting that it will decline, notes that when the Federal Home Loan Bank of New York sold its portfolio of manufactured housing securities last year, the bank took an 18 percent loss on the sale.

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