Government Frees Freddie, Fannie Reins Despite Huge Losses

NEW YORK (Reuters)- Fannie Mae and Freddie Mac could have billions of dollars more tofund home purchases after the government on Wednesday lifted caps onthe two largest U.S. mortgage finance companies to ease a housingcrisis.

The restrictions were lifted despite Fannie Mae’s staggeringquarterly loss of $3.6 billion as defaults and foreclosures surged. Thecompany also warned there could be a "significant" worsening in thereal estate market.

Fannie Mae and smaller rival Freddie Mac have lobbied their regulator to lift the restrictions on their combined$1.4 trillion portfolios to give them the ability to buy more mortgagesfrom lenders and support housing.

However, Fannie Mae’s chief executive officer said the company willbe conservative in using its capital to buy loans as it wants to limitlosses.

Fannie Mae shares surged after the Office of Federal HousingEnterprise Oversight said that on Saturday it will remove the caps onthe companies, known as government-sponsored enterprises, that haverestricted growth for three years. The portfolios provides most of thecompanies’ profit.

"The GSEs are really looked to as the last great hope for thehousing market," said Malcolm Polley, chief investment officer atStewart Capital Advisors in Indiana, Pennsylvania. "To the extent thatthey will be able to grow their portfolio, their earnings will grow."

Washington-based Fannie Mae on Wednesday posted a $3.80 per sharenet loss for the fourth quarter, compared with a profit of $604 millionin the year-earlier period. It stock tumbled in November when itreported a $1.52 billion third-quarter loss.

Analysts expected the company would post a fourth-quarter loss of $1.39 per share, according to Reuters Estimates.

Losses at Fannie Mae and rival Freddie Mac have constrained theirability to support the housing market that by some measures is in itsworst funk since the Great Depression.

Analysts said the key for Fannie Mae’s growth is the company’scapital, which rose last quarter to $3.9 billion above its regulatoryminimum.

"Our strategy for moving through another tough year is to protectand conserve our capital base, and control credit losses," Fannie MaeCEO Daniel Mudd said in a statement.

The GSE said it will suffer bigger losses on home loans than itforecast just three months ago as the declines in house pricesaccelerates and foreclosures rise. It increased its credit loss ratioforecast to a range of 11 basis points to 15 basis points in 2008 fromthe 8 to 10 basis points it forecast in November.

The forecast for the credit loss ratio, or losses as a percent ofthe loans it guarantees, is well above 5.3 basis points for 2007 and2.2 basis points in 2006, Fannie Mae said.

Falling home prices after years of loose underwriting standards anda speculative frenzy have filtered from risky subprime loans to theprime loans that make up most of Fannie Mae’s business, shockinginvestors who thought the company was better protected.

Fannie Mae said its results were largely driven by a $3.2 billionloss on derivative contracts used to hedge its investment portfolio asinterest rates declined.

Rising delinquencies and foreclosures also forced Fannie Mae towrite down the value of mortgage securities it owns and to increasereserves to cover their guarantees of payments on bonds held byinvestors.

Fannie Mae’s report "is disturbing," said Peter Kenny, managingdirector at Knight Equity Markets in Jersey City, New Jersey. "Itconfirms the market’s expectation, or fear, of another shoe to drop."

Credit-related expenses soared to $3 billion last quarter from $326million in the same period for 2006. Revenue rose 8.6 percent to $3.1billion, driven by a 26.4 percent increase in guaranty fee income.

The earnings report initially drove Fannie Mae shares to a 12-yearlow at $25.33, but OFHEO announcement on portfolio caps sent themrocketing as much as 17 percent higher. I early afternoon the stock wasup 2.8 percent at $27.72.

Regulators and lawmakers have leaned harder on Fannie Mae FannieMae, which was created in 1938 to boost homeownership, in recent monthsto bolster the housing market, most recently by increasing the size ofloans eligible for their purchase. However, losses at the companieshave squeezed their profits and reduced their ability to expand.

Fannie Mae shares have fallen 33 percent this year through themarket close on Tuesday, compared with a 3.8 percent drop in the KBWMortgage Finance index .MFX over the same period.

(Additional reporting by Herb Lash and Jennifer Ablan; Editing by Tom Hals)