Fannie and Freddie Lose Total of $3.1 Billion in Quarter

Fannie Mae and Freddie Mac, the government-sponsored entities that underwrite a majority of the nation’s mortgages, reported much worse than expected earnings this week.

Fannie Mae (NYSE: FNM), the largest U.S. buyer and backer of home loans, said Friday it lost $2.3 billion, or $2.54 a share, for the quarter that ended June 30. The loss compares with profit of $1.95 billion, or $1.86 a share, in the same period last year.

The announcement comes on the heels of similarly weak earnings reported earlier this week by Freddie Mac (NYSE: FRE). Freddie lost $821 million, or $1.63 a share, for the quarter. That was down from a $1.02 per share profit a year earlier.

Volatility and disruptions in the capital markets became even more pronounced in July," Daniel H. Mudd, Fannie Mae president and chief executive officer, said in a statement. "In addition, credit performance has continued to deteriorate and, based on our experience in July, we anticipate further increases in our combined loss reserves."

Fannie Mae said that more than 60 percent of its losses were from a small number of products, particularly Alt-A loans. Through recent underwriting changes, Fannie’s volume of these products has declined more than 80 percent from their peak levels. The GSE said that it has already made underwriting changes to mitigate risk characteristics that drove those losses. Fannie plans to eliminate newly originated Alt-A acquisitions by the end of the year.

“[We are] ramping up defaulted loan reviews to pursue recoveries from lenders, focusing especially on our Alt-A book,” the company said in its earnings release. “The objective is to expand loan reviews where the company incurred a loss or could incur a loss due to fraud or improper lending practices. To achieve this, we are increasing post-foreclosure loan reviews from 900 a month in January to 4,000 a month by the end of the year, expanding our quality-control reviews for targeted products and practices, and are on track to double our anti-fraud investigations this year. We expect this effort to increase our credit loss recoveries in 2008 and 2009.”

The outlook continues to be bleak for both GSEs for the next couple of years, John Jay, senior analyst at Aite Group, told insideARM. “Calling a bottom is very difficult. Real estate implosion is a slow moving train.”

Jay pointed out that there are still adjustable rate mortgages from late in 2006 and all of 2007 that have yet to reset to higher rates. When they do, it likely spells more trouble for the GSEs.

And the GSE problems aren’t limited to the current credit crunch, Jay added.

“They have such massive and continuing problems, I don’t even know where to begin,” Jay said. “Both of these are continually disappointing, they’ve had accounting scandals, senior guys being booted, and this thing coming down on their head. They both got lazy, and investors got lazy because of the implied government guarantee. No one paid attention to risk.”