Fannie Shares Recover After Grim Results

OFHEO lowered its requirement on Fannie to hold a surplus over minimum capital levels to 20% from 30% in mid-March in return for the company's commitment to raise new capital. Now OFHEO will lower the surplus to 15% after the capital has been raised, and it said it will lower it 5 basis points further in September. Freddie is expected to report results next week.

Howard Shapiro, analyst with Fox-Pitt Cochran Caronia, says that investors had expected Fannie's quarterly results to be ugly, but they were pleased that the company would be raising less capital than many had suspected it would. Also, increased fee rates and profit margins on new business were a positive sign for the future, and OFHEO's decision to further loosen the regulatory reins will allow Fannie to grow its business for the future despite the difficulties it's currently experiencing.

"This means [Fannie] can put more capital at risk to help our mortgage market," says Shapiro.

Fannie's expansion in the mortgage market will ease credit jitters for investors because the firm has implicit backing from the federal government. The Federal Reserve has already signaled that it will backstop the banking system when it helped JPMorgan Chase(JPM - Cramer's Take - Stockpickr) buy a near-bankrupt Bear Stearns (BSC - Cramer's Take - Stockpickr) in March and extended emergency liquidity to investment banks in return for illiquid collateral, like mortgage-backed securities. Many investors viewed the Fed's actions as evidence that it would also backstop Fannie and Freddie.

Both companies are suffering at the hands of a nasty downturn in the U.S. housing market, where prices are recording their largest declines on record since the Great Depression. The mortgage crisis has led to a rash of defaults on home loans in markets around the country, which has in turn provoked a credit crisis on Wall Street and a loss of confidence among investors. Investment banks like Citigroup (C - Cramer's Take - Stockpickr), Merrill Lynch (MER - Cramer's Take - Stockpickr) and Lehman Brothers (LEH - Cramer's Take - Stockpickr) have posted billions in losses on investments tied to the mortgage market.