Fannie Mae loses $2.3B in quarter as defaults rise

Fannie Mae is making bold cutbacks that will send shock waves through the mortgage market, after posting a quarterly loss Friday that was three times larger than Wall Street expected.

To slow its financial decline, the mortgage finance giant slashed its dividend to 5 cents a share from 35 cents a share and said it will eliminate loans for borrowers with solid credit scores, but little proof of income or small or no down payments.

The company also is raising its mortgage fees, which will be passed onto borrowers as higher interest rates or closing costs.

With Fannie Mae and its sibling company Freddie Mac becoming more risk-averse, fears are building that mortgage rates will keep climbing, making it harder for people to afford a mortgage or refinance their home, and spur even more foreclosures.

"We are already in that spiral," said Chris Mayer, real estate professor at Columbia Business School.

Volatility and disruptions in the capital markets worsened in July. And though Fannie Mae's losses should still peak this year, said Chief Executive Daniel Mudd, he couldn't predict how long the housing recession will last or how low prices will fall.

"The housing market has returned to earth fast and hard," Mudd said.

Disappointed stockholders sent Fannie Mae's shares down 9.1 percent, or 90 cents, to $9.05 Friday.

Investors continue to worry that Fannie and Freddie will be overwhelmed by losses and require government aid. Fannie Mae and Freddie Mac, are the biggest buyers of U.S. home loans from banks and other lenders. Together they own or guarantee nearly half of outstanding U.S. mortgage debt.

Under the housing bill signed by President Bush last week, the government may boost lines of credit to the companies or buy their stock.

Mudd, however, said the company has no plans to use that financial lifeline. "We're going to manage our way through it," he said.

While Fannie and Freddie generally had higher standards for lenders than the subprime mortgage companies that started going belly-up at the end of 2006, the duo lowered their standards during the housing boom and bought securities linked to riskier loans.

Even as the subprime mortgage market collapsed, the industry - backed by Fannie and Freddie - kept making risky so-called Alt-A loans. They made up about 15 percent of all loans in the first half of 2007, up from 13 percent in all of 2006, according to trade publication Inside Mortgage Finance.

For Fannie and Freddie, these Alt-A loans made up roughly 10 percent of their portfolios but accounted for more than half of their losses in the second quarter. The souring loans were concentrated in California, Florida, Nevada and Arizona, where speculation was rampant, prices soared and homeowners stretched to the financial limit to afford a home.

If Freddie Mac follows Fannie Mae and stops buying Alt-A loans, "it means that market is not going to exist at all. It's barely hanging on now," said Guy Cecala, publisher of Inside Mortgage Finance,

For homebuyers who don't have stellar credit and a big down payment, there are few options these days but loans insured by the Federal Housing Administration. Those loans require a minimum of 3.5 percent down and full proof of income.

What's more, Fannie Mae's new fees will price more borrowers out of the market. For a borrower with less-than-perfect credit, such fees could hike closing costs by $3,000 for a borrower with a $300,000 mortgage, or raise payments by $50 per month, said Patrick Cunningham, a vice president with Home Savings & Trust Mortgage in Fairfax, Va.

To avoid such fees, "paying attention to your credit is going to be paramount for people," he said.

But Fannie Mae didn't have much choice.

The Washington-based company lost $2.3 billion, or $2.54 a share, for the quarter that ended June 30. The loss, the company's fourth-consecutive quarter of red ink, compares with profit of $1.95 billion, or $1.86 a share, in the period last year.

Analysts surveyed by Thomson Financial had expected a loss of just 68 cents a share.

While revenue rose to $3.97 billion from $1.42 billion a year earlier, Fannie Mae's losses from defaulting mortgages skyrocketed.

Fannie Mae booked $5.3 billion in credit expenses, including a $3.7 billion addition to its loss reserves. Loans three-months past due or more than doubled last year's level to 1.36 percent.

The company said it is boosting efforts to recover money from lenders who committed fraud in loans that were sold to the company.

To speed up the sale of foreclosed properties, Fannie Mae is opening offices in California and Florida and said it would consider selling those properties in bulk to investors. "I do not think this is a time to be holding onto (foreclosed properties) hoping for a better day," Mudd said.