Fannie Mae Set to Report Record Loss as Allison Cleans House

By Dawn Kopecki

Nov. 6 (Bloomberg) -- Fannie Mae may post a record net loss in its first quarterly report since being seized by the U.S. government as Chief Executive Officer Herb Allison writes off bad debts and increases default estimates.

The mortgage-finance company may say its third-quarter loss was at least $20 billion, including a previously announced plan to write down most of its tax credits, according to Howard Shapiro at Fox-Pitt Kelton Inc. in New York. Washington-based Fannie may post results as early as tomorrow.

Allison, installed when the government seized Fannie and the smaller Freddie Mac on Sept. 6, may use the report to slash the value of assets, as well as boost loss provisions and default estimates, said Paul Miller, an analyst at Friedman Billings Ramsey in Arlington, Virginia. Fannie has already posted losses of $9.4 billion in the past year as the worst housing market since the Great Depression increased defaults.

``Right now the market's numb about how bad the housing market is,'' Miller said. ``So why not clean the books out and clean it up.''

Fannie's new management will likely increase reserves for future credit losses from $3.7 billion last quarter and will take a higher-than-expected charge against its $5.2 billion in ``temporary'' losses, Miller said. Fannie also may increase its 2008 credit-loss ratio projection and post losses on its derivatives portfolio.

``It's going to be an ugly quarter,'' Shapiro said. Fannie has ``a new management team, it's got a new mission and they really have no stake in running it for profit right now.''

Sugar Coating

Fannie's writedown of its deferred tax assets, valued at $20.6 billion as of June 30, will potentially cut its book value in half and increases the likelihood the U.S. Treasury may need to pump cash into the mortgage-finance company. If McLean, Virginia-based Freddie follows suit as analysts expect, it would need to write down more than $18 billion, leaving it with a book value of negative $6 billion and triggering the Treasury aid.

The Federal Housing Finance Agency placed Fannie and Freddie under federal control and forced out management after examiners found their capital to be too low and of poor quality. Treasury Secretary Henry Paulson pledged to invest as much as $100 billion in each company as needed to keep their net worth positive.

The companies will need that money ``sooner rather than later,'' according to Miller. Allison, 65, will likely implement more conservative accounting policies and will need to write down higher-than-expected credit costs, Miller said.

Temporary Impairments?

Fannie and Freddie own or guarantee at least 40 percent of the $12 trillion in U.S. residential-mortgage debt outstanding. They make money by buying home loans and mortgage securities, profiting on the difference between their cost of borrowing and the yield on the debt. They also guarantee and package loans as securities for a fee.

Examiners from the Federal Reserve, who helped FHFA review the companies' books, found that in addition to thin capital, the Fannie and Freddie may have been understating their losses, Dallas Federal Reserve President Richard Fisher said last month.

``When you look at temporary impairments and so on, we found that many of them might not be so temporary,'' Fisher said in response to an audience question after a Sept. 8 speech in Austin, Texas.

With Fannie under government conservatorship, Allison isn't as beholden to shareholders as his predecessor Daniel Mudd.

Because Fannie and Freddie's market value was nearly wiped out with the federal takeover, Miller said, ``the new management team has no incentive to sugar coat their earnings.''

Interest-Rate Bet

Fannie and Freddie, which traded around $50 a year ago, are under $1 now. Goldman Sachs Group Inc., Merrill Lynch & Co. and at least eight other analysts have dropped or suspended equity coverage now that regulators are pushing Fannie and Freddie to aid the mortgage market, even at the expense of profitability.

Fannie and Freddie may also post some losses on their derivatives portfolio after hedging against rising interest rates in the third quarter. The Federal Reserve cut its benchmark target interest rate twice in October by 0.5 percentage point to a 50-year low at 1 percent.

``They did more short term debt layered with derivatives to lengthen the maturity,'' said Moshe Orenbuch, an analyst with Credit Suisse in New York. ``With rates falling, the value of their securities declines.''

Fannie reported a loss of $2.3 billion last quarter, and $1.4 billion in the three months ended Sept. 30, 2007. Fannie has booked $9.4 billion in cumulative losses over the previous four quarters.

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net.