Fannie Mae loans will cost more

Faced with huge losses tied to foreclosures, the lender wants borrowers to cover more expenses

WASHINGTON -- Fannie Mae is making bold cuts that will send shock waves through the mortgage market, after posting a quarterly loss Friday that was three-times larger than Wall Street expected.

To slow its financial decline, the mortgage finance giant slashed its dividend to 5 cents a share from 35 cents a share. It also will eliminate loans offered to borrowers who have solid credit scores but little proof of income or small or no down payments.

The company also is raising its mortgage fees, which will be passed to borrowers as higher interest rates or closing costs.

With Fannie Mae and its sibling company Freddie Mac becoming more risk-averse, fears are building that mortgage rates will keep climbing, making it harder for people to afford a mortgage or refinance their home, and spur even more foreclosures.

"We are already in that spiral," said Chris Mayer, real estate professor at Columbia Business School.

Volatility and disruptions in the capital markets worsened in July. And though Fannie Mae's losses are expected to peak this year, chief executive Daniel Mudd said he couldn't predict how long the housing recession will last or how low prices will fall.

"The housing market has returned to Earth fast and hard," Mudd said.

Dismayed stockholders sent Fannie Mae's shares down 9.1 percent, or 90 cents, to $9.05.

Investors continue to worry that Fannie Mae and Freddie Mac will be overwhelmed by losses and require government aid. The two are the biggest buyers of U.S. home loans from banks and other lenders. Together they own or guarantee nearly half of outstanding U.S. mortgage debt.

Under the housing bill President Bush signed last week, the government can boost lines of credit to Fannie or Freddie or buy their stock.

Mudd, however, said the company has no plans to use that lifeline. "We're going to manage our way through it," he said.

Fannie and Freddie generally had higher standards for lenders than the subprime mortgage companies that started going belly-up at the end of 2006.

However, the duo lowered their standards during the housing boom and bought securities linked to riskier loans.

Even as the subprime mortgage market collapsed, the industry -- backed by Fannie and Freddie -- kept making risky Alt-A loans. They made up about 15 percent of all loans in the first half of 2007, up from 13 percent in all of 2006, according to trade publication Inside Mortgage Finance.

Alt-A loans made up about 10 percent of Fannie and Freddie's portfolios but accounted for more than half of their losses in the second quarter. The souring loans were concentrated in California, Florida, Nevada and Arizona, where speculation was rampant, prices soared and homeowners stretched to the financial limit to afford a home.

If Freddie Mac follows Fannie Mae and stops buying Alt-A loans, "it means that market is not going to exist at all. It's barely hanging on now," said Guy Cecala, publisher of Inside Mortgage Finance,

But Fannie Mae didn't have much choice. The company, which is based in Washington, lost $2.3 billion, or $2.54 a share, for the quarter that ended June 30. The loss, the company's fourth-consecutive quarter of red ink, compares with profit of $1.95 billion, or $1.86 a share, in the period last year.

Analysts surveyed by Thomson Financial had expected a loss of just 68 cents a share.

Revenue rose to $3.97 billion from $1.42 billion a year earlier, but Fannie Mae's losses from defaulting mortgages skyrocketed.

Fannie Mae booked $5.3 billion in credit expenses, including a $3.7 billion addition to its loss reserves. Loans that were three-months past due more than doubled last year's level to 1.36 percent.

The company said it is increasing its efforts to recover money from lenders who committed fraud in loans that were sold to the company.

To speed up the sale of foreclosed properties, Fannie Mae is opening offices in California and Florida and said it would consider selling those properties in bulk to investors.

"I do not think this is a time to be holding onto ... [foreclosed properties] hoping for a better day," Mudd said.