Fannie Mae Predicts Price Decline Will Accelerate in '08

[MS08VIPER]

Fannie Mae, the mortgage finance giant, yesterday predicted that housing prices will decline by 2 percent on average this year and by 4 percent next year as mortgage delinquencies rise, lenders tighten borrowing standards and the volume of unsold homes approaches record levels.

"This is clearly a market poised for more severe overall credit losses," Enrico Dallavecchia, Fannie Mae's chief risk officer, said in a conference call with investment analysts.

Adding to the trouble, Dallavecchia said, is that many borrowers with adjustable-rate mortgages are facing rising monthly payments, which could drive them into foreclosure. "This could have a cascading effect in the market," he said.

Fannie Mae, which was chartered by the government to keep money flowing to mortgage lenders, offered its assessment yesterday as it provided an update on its financial condition. The company has been arguing that it could help stabilize troubled mortgage markets if regulators loosened restraints on its business, but that plea was rejected last week.

District-based Fannie Mae said it was less vulnerable to the turmoil than other players in the mortgage industry and could wind up with a larger share of the market. "We'll come out of this in pretty good shape," chief executive Daniel H. Mudd told analysts.

As of June, Fannie Mae owned or guaranteed more than 38 percent of the non-jumbo mortgages outstanding in the United States, up from about 25 percent at the end of 2006, the company said.

Fannie Mae's account of its prospects appeared to make an impression on investors, who bid up the company's stock price yesterday by 6.1 percent.

Fannie Mae has two main businesses: investing in mortgages and packaging them into securities for sale to other investors. When the company packages the mortgages as securities, it promises to pay investors the principal and interest due on the loans if the borrowers default.

Fannie Mae's share of the overall mortgage market shrank during the recent housing boom as lenders peddled an array of unconventional loans outside the company's traditional sphere of business. Some loans made home purchases possible for borrowers with weak credit histories or undocumented incomes. Others featured low teaser rates that later increased or monthly payments so low that the principal balance on the loans actually grew over time.

Fannie Mae waded into the subprime and unconventional segments, too, but not as deeply as many other investors.

Now, as nontraditional loans lose favor, business is shifting toward Fannie Mae and its direct competitor Freddie Mac. Meanwhile, investors' demand for subprime and unconventional loans has been drying up, contributing to a broader credit crunch.

In another sign of stress in the housing sector, the Commerce Department yesterday reported that new-home construction last month slowed to its lowest rate in more than a decade.

Although Fannie Mae owns hundreds of billions of dollars of investments in subprime and unconventional mortgages, they represent a minority of its holdings. The company could withstand "the direst of scenarios" -- two years of 10 percent declines in home prices coupled with two years of 2 percent increases in interest rates -- with "very little loss in cash flow," Dallavecchia told analysts.

The company said its reserves for losses from mortgage delinquencies and related problems as of Dec. 31 totaled $859 million, or three hundredths of a percent of its book of businesses. On a percentage basis, that was unchanged since 2003.

Fannie Mae held yesterday's conference call to discuss its long-delayed annual financial report for 2006. Among other data, the report noted that, after correcting past financial results, the company determined that it previously paid executives more stock under an incentive compensation plan than the executives were due. A Fannie Mae spokeswoman declined to comment on that disclosure.

The company has been unable to issue financial results on a timely basis since an accounting scandal in 2004 revealed that it had overstated income by billions of dollars. The inability to issue timely reports is one of the issues regulators cited in refusing to loosen restraints on Fannie Mae.

The company reiterated yesterday that it plans to resume timely financial reporting early next year.

The company said its 2006 profit declined 36 percent, to $4.1 billion, from $6.3 billion in 2005.

One factor was an increase of about $1 billion in expenses related to getting the company's accounting and financial reporting back on track. Another factor was a decline in the volume of the company's mortgage investments.

In reaching a $400 million settlement with regulators last year over its accounting problems, Fannie Mae accepted a cap on its holdings of mortgages and mortgage-backed securities. The cap remains an impediment to the company's earnings growth, and it could prevent Fannie Mae from taking advantage of the market's current distress to scoop up large volumes of mortgage-related investments at deeply discounted prices.

Fannie's chief executive yesterday restated his argument that if regulators raised the cap, Fannie Mae could help ease problems in the mortgage arena.

"We think this is what the company was built for," Mudd said.

One analyst asked Mudd whether regulators "understand the gravity of the situation."

Mudd dodged the question, joking, "Either you're trying to get me fired or actually killed."