Regulator Lifts Caps on Fannie, Freddie

Fannie raised its estimate for a national decline in home prices in 2008 to a 5% to 7% drop. Previously, it had expected a 4% to 5% decline. It also forecasts a total peak-to-trough decline of 13% to 17%, up from its earlier view of 10% to 12%.

Moreover, Fannie sees its credit loss ratio, used to judge the credit quality of its existing guaranty book of business, increasing 11 to 15 basis points, up from its earlier view of 8 to 10 basis points.

"We are working through the toughest housing and mortgage markets in a generation," Mudd said. "Our results for 2007 reflect the challenging conditions in the market we serve. While we are pleased that demand for our mortgage guaranty businesses has surged as we respond to the market's urgent need for liquidity and stability, this positive trend has been far outweighed by the negative financial impacts of rising mortgage defaults, falling home prices, and extraordinary disruptions in the credit markets."

CFO Stephen Swad noted an extremely illiquid credit market led to a majority of 2007's losses in the form of mark-to-market valuation declines. The company's five-year swap rate, used to shield the fair value of its net assets against fluctuations in short- and long-term interest rates, declined by 131 basis points in the fourth quarter

To bolster Fannie's capital position, Swad pointed to the $7.8 billion the company raised in a preferred stock sale in the fourth quarter.

"We will continue to evaluate further avenues to conserve our capital and reduce the impact of market disruptions on our capital base," Swad said.

About half of the $5.01 billion in full-year credit-related losses were due to an increase in loan loss provisions to backstop bad loans charged off in some of the country's worst housing markets. Fair value losses to loans purchased from mortgage-backed securities spiked to $1.4 billion in 2007 from $204 million in 2006. Fannie often buys the delinquent loans in an effort to prevent foreclosures.

"Right now, everyone is focused on the severity of credit losses on the private label, but the biggest risk is that people don't fully appreciate that Fannie and Freddie's core business on the guarantee side is susceptible to significant deterioration in conforming conventional credit quality," says Rosner.