Fannie Mae inquiry widens

Federal regulator notes new concerns over `safety and soundness'

Mortgage accounting questioned


WASHINGTON - Fannie Mae, the nation's largest buyer of home mortgages, said yesterday that its primary regulator has found a host of new potential accounting violations at the company that have raised a fresh set of "safety and soundness concerns."

The government-chartered company also said regulators had decided to give it a three-month extension, until the end of September, to carry out a plan to raise billions of dollars in capital and reduce its portfolio of mortgage securities.

In an attempt to control a crisis that began last fall after a highly critical report from its chief regulator, Fannie Mae said its cost-cutting measures would include sharply curtailing its use of political consultants and lobbyists. For years, Fannie Mae has been one of the most prodigious employers of Republican and Democratic lobbyists and political consultants as it beat back attempts in Congress for tighter regulation.

Neither Fannie Mae nor its regulator, the Office of Federal Housing Enterprise Oversight, would say how the possible accounting violations might affect the company's previous earnings, balance sheet or net capital requirements, noting that the inquiry is continuing and could take months to complete.

Fannie Mae said the regulator's findings indicate that the company had used practices that "appear to be inconsistent with `generally accepted accounting principles.'"

"The restatement process may result in additional adjustments, perhaps material adjustments, to prior and current period financial results," Fannie Mae said.

Wall Street did not seem deeply troubled by the news of further accounting problems, although Fannie Mae's stock continued its slide. The shares fell 64 cents yesterday to close at $57.16, their lowest level in more than four years and about 30 percent below their high of $80.82 last year.

The problematic practices that the regulator identified include the way the company accounts for mortgage-backed securities and loans, its use of "qualified special purpose entities" to issue mortgage-backed securities and "practices to smooth certain income and expense amounts," the company said.

In one instance, the regulator questioned Fannie Mae's use of the held-to-maturity classification for mortgage securities that should have been classified as available for sale. The accounting designation is important because loans for sale must be given a market value quarterly and are accounted for much as inventory would be in a nonfinancial business.

"The implication is that Fannie Mae is classifying certain transactions in a self-serving manner so as to enable them to manage their earnings," said Michael Granof, a professor of accounting at the University of Texas at Austin. The designation of which securities are to be sold "could have a very significant impact on earnings," he said.

"Management has initiated a comprehensive review of accounting routines and controls, the financial reporting process and the application of generally accepted accounting principles," Fannie Mae said.

A finding two months ago by the chief accountant at the Securities and Exchange Commission that Fannie Mae had violated two accounting principles forced the company to wipe as much as $9 billion in earnings from its books and prompted it to scramble to meet its capital obligations.

The SEC made its finding after the housing oversight agency reached similar, more far-reaching conclusions in September.

The company issued $5 billion in preferred stock in December and cut its dividend in half as part of a plan to restore its capital, the financial cushion required by regulations to ensure that the company is able to meet its financial obligations. The company has also been steadily selling off its enormous portfolio of mortgages to reduce the overall size of its assets, part of its plan to meet its capital requirements.

This week, the company reported that its gross portfolio - which includes its own investments along with mortgage-backed securities that it guarantees but are held by others - fell to $890 billion at the end of last month from $904.6 billion a month earlier.

In its statement yesterday, Fannie Mae said the housing oversight agency had granted the company a three-month extension of the deadline to complete its plan to increase its capital reserves, to Sept. 30.

The company is expected to submit a plan by the end of this week to strengthen its financial and risk management programs.

Last month, Fannie Mae announced that in addition to issuing stock, it would undertake cost-cutting measures to restore its capital, including the denial of bonuses to 45 top executives, most notably Franklin D. Raines and J. Timothy Howard, who were ousted as the top two executives after the report by the chief SEC accountant.

The company said cost-cutting measures would include sharp cutbacks in advertising and use of political consultants.

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