By Robert Schroeder WASHINGTON (MarketWatch) -- U.S. lawmakers urged tougher regulations for government-sponsored mortgage finance company Fannie Mae (FNM) during a House hearing Wednesday, as the SEC's chief accountant said the agency continues to "thoroughly" investigate the company's accounting. Chief accountant Donald Nicolaisen is testifying before a House Financial Services subcommitte that is considering new legislation for the mortgage giant.
19Jan- FNM announced that it will cut its 1Q05 common dividend by 50% in order to help it reach its 30% target capital surplus level, presumably by mid-2005. (Needless to say, the Lehman, SB, JP Morgan anal-ysts LOVE it)
Accounting Problems at Fannie Mae Authors: Mark Jickling, Government and Finance Division http://www.pennyhill.com/housing/rs21949.html Abstract: On September 22, 2004, the Office of Federal Housing Enterprise Supervision (OFHEO) made public a report that was highly critical of accounting methods at Fannie Mae, the government-sponsored enterprise that plays a leading role in the secondary mortgage market. OFHEO charges that Fannie Mae has not followed generally accepted accounting practices in two critical areas: (1) amortization of discounts, premiums, and fees involved in the purchase of home mortgages and (2) accounting for financial derivatives contracts. According to OFHEO, these deviations from standard accounting rules allowed Fannie Mae to reduce volatility in reported earnings, present investors with an artificial picture of steadily growing profits, and, in at least one case, to meet financial performance targets that triggered the payment of bonuses to company executives. On September 27, Fannie Mae’s board of directors agreed to correct the accounting deficiencies, augment the firm’s capital surplus, review staff structure and internal controls related to accounting, and to appoint an independent chief risk officer. The Securities and Exchange Commission (SEC) and Justice Department are investigating. On November 15, 2004, Fannie Mae reported that it was unable to file a third-quarter earnings statement because its auditor, KPMG, refused to sign off on the accounting results. Fannie also estimated that if its derivatives accounting is found to be incorrect, it might have to report a third-quarter loss of about $9 billion.
Q. With the latest troubles that Fannie Mae is having, what impact will there be on its stock? -- D.R., via the Internet
A. Accounting investigations are negative for any company, but especially one that regulators have wanted to rein in for a long time.
This federally chartered, stockholder-owned company benefits from holding an impressive $895 billion in mortgages in the attractive and relatively stable U.S. housing market. However, confidence in its management and its financial figures is slipping away.
Shares of the Federal National Mortgage Co. (FNM), or Fannie Mae, are down 10 percent this year, following last year's 20 percent gain.
In a 200-page report, the Office of Federal Housing Enterprise Oversight, which regulates Fannie Mae, cited serious accounting problems and accused it of earnings manipulation. There may be a restatement of earnings and the Securities and Exchange Commission is also investigating.
Fannie Mae reportedly put off $200 million in expenses in 1998 so that its executives could receive full bonuses. The opulence of the company's headquarters is well known. Furthermore, the oversight office contends management didn't adequately respond to concerns raised by one of Fannie Mae's own accountants or even the oversight office investigation.
In response to the regulators' charges, Fannie Mae's eight outside directors agreed to revamp accounting processes and increase by 30 percent over the regulatory minimum the capital reserve surplus against risk. The oversight office has begun publishing monthly updates on the company's capital position.
The futures of Fannie Mae Chairman and Chief Executive Franklin Raines and Chief Financial Officer J. Timothy Howard are in doubt, with regulators saying the company's board must decide whether they should be removed. Meanwhile, the board hired a chief risk officer.
Fannie Mae shares currently receive a consensus recommendation between a "buy" and a "hold" from the analysts who track the stock, according to the Boston-based First Call research firm. That consists of five "strong buys," six "buys," seven "holds" and two "sells."
Fitch Ratings has lowered the company's subordinated debt and preferred stock ratings one notch to AA- while other agencies have put the company on watch for the time being.
According to analyst estimates, Fannie Mae earnings are expected to increase 6 percent this year, half the 12 percent predicted for the consumer financial-services industry. Next year's projected 4 percent gain trails the forecast of 9 percent for its peers. The predicted five-year annualized rise of 12 percent for Fannie Mae is the same as that expected industrywide.
Andrew Leckey is a Tribune Media Services columnist. E-mail him at yourmoney@tribune.com.
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