Fannie Warns of $9 Billion Loss
If Derivatives Ruling Is Adverse
By JAMES R. HAGERTY
Staff Reporter of THE WALL STREET JOURNAL
November 16, 2004; Page A3
Fannie Mae estimated that it will have to post an after-tax loss of $9 billion if the Securities and Exchange Commission finds that the company has been accounting improperly for derivatives.
The estimate, based on the derivatives' value as of Sept. 30, is toward the high end of Wall Street expectations formed since September. At that time, the Office of Federal Housing Enterprise Oversight, or Ofheo, which regulates Fannie, released a report accusing the company of distorting its books to make earnings appear less choppy than they really are. In a news release yesterday, Fannie repeated its rejection of Ofheo's charges that the company improperly applied accounting rules known as FAS 133 and FAS 91. The SEC may study the issues for months before ruling, people familiar with the process have said.
Any loss would be recorded after the SEC makes its ruling, but the company didn't indicate how or when such a loss would be recorded.
Fannie said it has found one aspect of its method for applying FAS 91 was inconsistent with generally accepted accounting principles, or GAAP. Fannie said it believes the effects of correcting the method for 2001 through 2003 will net to zero.
Based on its current accounting practices, Fannie said its net income for the third quarter fell 9% to $2.42 billion, or $2.45 a share, from $2.67 billion, or $2.69 a share, a year earlier. The company cited a narrower margin between its borrowing costs and the interest it earns on home mortgages in its portfolio.
Fannie said it won't file on a timely basis a 10Q report with the SEC for the third quarter, because its outside auditor, KPMG LLP, has been unable to complete its review of financial statements for the period. Completion of that review is subject to resolution of the SEC investigation of Fannie's accounting methods, among other things, Fannie said. A KPMG spokesman declined to comment.
Fannie and its smaller rival, Freddie Mac, are chartered by Congress to pump money into the home-mortgage market, but are owned by private shareholders. They buy mortgages from banks and other lenders, providing them with funds to make new loans.
If the SEC forces Fannie to recognize the estimated $9 billion loss, the company likely will fall short of its minimum capital requirements. Among its options for shoring up capital would be selling some of the mortgages it holds on its books, slowing its purchases of new loans or making an offering of preferred stock. David S. Hochstim, an analyst at Bear Stearns, said Fannie easily could cope with a $9 billion hit, which he called a "worst-case estimate." He estimated that the company's core capital stood at $38 billion as of Sept. 30. Bear Stearns provides investment-banking services to Fannie, and Mr. Hochstim owns shares in the company.
But Bert Ely, a financial analyst in Alexandria, Va., who is a longtime critic of the company, said the latest disclosures reinforce his view that Fannie's chief executive officer, Franklin D. Raines, and chief financial officer, Timothy Howard, won't be allowed to keep their current posts. A Fannie spokesman declined to comment.
Ofheo has charged that in accounting for derivative contracts used to hedge interest-rate risks, Fannie incorrectly applied FAS 133 in a way that allowed it to spread out losses over many years rather than taking an immediate hit. Ofheo also has said Fannie gave itself too much leeway under rule FAS 91. That rule covers accounting for the amortization of premiums and discounts on loans. For example, if Fannie buys a loan for $100 more than the loan's par, or face, value, the company must write off that $100 premium over the expected life of the loan. When interest rates change, however, Fannie has to revise its assumptions about how soon people will pay off loans. When assumptions change, the company must adjust the rate of amortization.
Fannie said it used projections about conditions at the end of the year to calculate these "catch up" adjustments during 2001 and 2002. Instead, the company said, it should have been using conditions at the end of the latest quarter to calculate the adjustments.
Other companies also are being forced to revise the ways they comply with FAS 133, a set of rules that many mortgage-industry executives say gives a distorted view of earnings, because some balance-sheet items are marked to the current market rate and others are left at historical cost.
Also yesterday, the Federal Home Loan Bank of Chicago announced a delay in the release of its third-quarter results, pending an analysis of changes in the way the bank applies FAS 133. The changes were recommended by KPMG, hired recently as a consultant to review accounting practices. The changes are one result of a broader review of policies and practices ordered in June by the bank's regulator, the Federal Housing Finance Board. After the analysis is completed, "in the coming weeks," the bank said, it will determine whether the accounting changes have a material effect on past results. Based on the analysis so far, the bank said, the changes are likely to increase net income from past periods and to have no material effect on the bank's total capital as of Sept. 30.
Impac Mortgage Holdings Inc., Newport Beach, Calif., in July announced a restatement of its results for 2001 through 2003. Among other reasons, Impac cited the need to correct its application of FAS 133, saying its documentation of certain hedges wasn't sufficient to allow it to use so-called hedge accounting and defer recognition of gains and losses. Impac, like Fannie, uses KPMG as its outside auditor. |
