November 28, 2007 - After announcing that it would have a $1.4 Billion loss due to increased foreclosure rates in the third quarter of this year, FannieMae made a second announcement that it would be selling $3 Billion in bonds. These bonds will be backed by mortgages. The bond sale will allow the quasi-government FannieMae to continue to invest in new mortgages. But whether or not the bonds are a good investment is questionable due to a change in the company's accounting practices.

Due to the $1.4 billion loss, FannieMae had to announce that it might have to slow or halt the purchase of new mortgages. This would be extremely bad for the economy as a whole. Even though secondary mortgage markets have soured over the past three months, FannieMae and its sister companies have significantly softened the blow. If they were to stop all purchases of new mortgages, the net effect would be to make it significantly more difficult for most consumers to get a home loan. This would be true for everyone, including those with excellent credit.

To get around the problem, FannieMae decided on a bond sale. Given the fact that most of the loans made by the company are to borrowers with good credit, purchasing these bonds might seem like a reasonable investment. But a recent report in Fortune Magazine might make investors think long and hard prior to buying the companies new bonds.

Simply put, FannieMae has changed the way it calculates its credit loss ratio. Historically, the company has seen anywhere from .04 to .06 percent of its loan portfolio go into foreclosure. In its most recent quarterly statement, the company said that its loss ratio for the last quarter was .04 percent. This would appear to be good news because the losses are at the low end of the company's historical averages. But using the company's old accounting methodology the losses would actually appear to be in the area of .075 percent - almost double what they actually stated.

As ACCESS previously reported, FannieMae's losses are a clear indicator that the trouble with mortgage markets is now impacting prime borrowers. If the trend continues, FannieMae's losses will almost certainly increase. The change in accounting procedures, which was literally buried in the company's earnings statement, appears to be an attempt to mislead investors prior to the announced bond sale.

ACCESS is advising its readers to proceed with caution in the event they are interested in investing in mortgage backed securities of any kind; even from agencies like FannieMae and FreddieMac. There is the very real potential that as home values continue to plummet, and foreclosures continue to rise, that these securities will go down in value. They could even become worthless.

While we do want to see FannieMae continue to purchase mortgages, we don't want to see investors get hurt because of an accounting change.

by Jim Malmberg

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