Will Fannie Mae Have To Add Reserves?

The Office of Federal Housing Enterprise Oversight's (OFHEO) focus on Fannie Mae's accounting raises the chance Fannie may have to set aside additional capital as a reserve for its hedging activities, according to fixed-income professionals.

  • 24 Sep 2004
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The Office of Federal Housing Enterprise Oversight's (OFHEO) focus on Fannie Mae's accounting raises the chance Fannie may have to set aside additional capital as a reserve for its hedging activities, according to fixed-income professionals. Some are even speculating Fannie may have to increase its borrowing in the agency market.

The regulator last week released a report on the mortgage giant's accounting practices detailing $12.2 billion in deferred losses relating to hedging activities and may require the company to reclassify its losses and possibly restate earnings.

OFHEO's requiring a government-sponsored enterprise to increase its capital reserve is not without precedent. Freddie Mac disclosed last June it had understated profits by $4.5 billion from 2000-2002 to smooth earnings and was fined $125 million in its settlement with OFHEO. The regulator also required Freddie to increase its reserve capital by 30%. Jason Lobo, Fannie spokesman, declined comment on any future issuance. An OFHEO spokeswoman also declined comment.

Still, market professionals said it is too early to tell what will happen with Fannie. "It's a pretty complicated accounting issue and not clear to me that they would have to raise capital," said Larry Dyer, agency strategist at Credit Suisse First Boston. "This only affects the volatility with which the economics are reported. If there is a deficit because there is a loss today, you could see this issue become very reduced over a one-to-three year horizon."

If Fannie does turn to the agency bond market to increase its reserve, it will come at a higher price since spreads on its outstanding notes widened last week due to the report (see story, page 4). "They are losing a bit of liquidity," said Mike Alfstad, president of RW Smith Fixed Income, a broker/dealer that specializes in fixed income. "If it becomes necessary to raise additional capital, the cost will be influenced by [the investigation]," he added. Alfstad declined to speculate on how much capital Fannie Mae would have to raise.

  • 24 Sep 2004

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