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Fannie Mae’s bookkeeping questioned

WASHINGTON – Fannie Mae’s bookkeeping is drawing scrutiny from Wall Street – again.

Three years after a stunning accounting scandal that forced it to restate earnings by $6.3 billion, the government-backed home-loan finance company now is on the defensive over a change in how it calculates potential losses from the growing mortgage crisis.

The fear among investors is that a new accounting methodology masks the number of bad loans held by Fannie, thus downplaying potential losses.

Shares of Fannie, the largest U.S. buyer and backer of home mortgages, tanked for the second day in a row Friday, even as executives tried to assuage skeptical Wall Street analysts in a conference call.

Fannie first disclosed the new way it has decided to calculate its mortgage losses Nov. 9, when it submitted several hundred pages of documents to the Securities and Exchange Commission to bring the company’s financial reporting up to date for the first time since 2004. But the bookkeeping change – and its potential impact – received significant attention Thursday in an article published online by Fortune, which is owned by Time Warner.

Using the new method, Fannie reported an “annualized credit-loss ratio” of 4 basis points for the first nine months of this year, meaning it lost money on four of every 1,000 mortgages it holds on its $2.4 trillion book. The Fortune article pointed out that if the old method were retained, the credit-loss ratio for that period would have been 7.5 basis points – far exceeding Fannie’s forecasts.

The adjustment is particularly unnerving to Wall Street because the company was racked by an accounting scandal in 2004 that tarnished its reputation and brought government sanctions against it.

“This just smacks too much of the accounting games the company was playing a couple years ago,” said Armando Falcon, who headed the Office of Federal Housing Enterprise Oversight, the federal agency regulating government-sponsored Fannie Mae, at the time its accounting crisis erupted.

“They have very little room to play with here when it comes to trust and credibility,” Falcon said in a telephone interview, adding that “it doesn’t bode well for the new management.”

The latest accounting uproar comes as Fannie pressures the government to raise the mandated cap on its mortgage investment holdings, now set at $735 billion, as a way to help calm jittery credit markets.

“With this news, there is absolutely no justification” for Fannie being allowed to assume additional debt, said Rep. Richard Baker, R-La., a member of the House Financial Services Committee who is a longtime critic of the company. “We don’t know the embedded risk yet.”

The reaction on Wall Street was only slightly more forgiving.

Citigroup analyst Bradley Ball said while Fannie executives provided helpful explanations of some confusing accounting issues during Friday’s conference call, the company “continues to fall short on providing sufficient detail for clear analysis of core operating results.”

“Management was unable to assuage the market’s main concerns about credit losses going forward,” Ball wrote in a research note.

Washington-based Fannie reported a $1.4 billion third-quarter loss last week, while forecasting industry troubles through next year because of mounting home loan delinquencies.

In Friday’s conference call, Chief Financial Officer Stephen Swad said some of the $670 million in provisions for credit losses on soured home loans that Fannie wrote off in the third quarter likely would be recovered.

“We book what we book under (generally accepted accounting principles) and we provide this disclosure to help you understand it,” Swad said.

Several analysts asked the executives in the conference call why the company couldn’t disclose what proportion of high-risk mortgages it is able to refinance into fixed-rate loans and save from default.

“The problem is that we don’t have the underlying information,” said Credit Suisse analyst Moshe Orenbuch.

Another analyst said in a report that Fannie’s new calculation method is similar to that used by Freddie Mac, its smaller government-sponsored sibling. Spokesmen for Freddie Mac didn’t immediately confirm that.

The current director of the Office of Federal Housing Enterprise Oversight, James B. Lockhart, would not have any comment Friday on the Fannie Mae matter, a spokeswoman said.