Mortgage lender Fannie Mae arranged a conference call Friday to clarify two accounting issues that affected the company’s income statement. But the analysts on the call seemed more interested in focusing on a single word — “majority” — and its effect on future losses than the columns of numbers the company released in regulatory filings earlier this month.
Indeed, analysts were fixated on the company’s third-quarter financial filings. Those revealed that, based on the company’s previous experience, “the majority of the loans we purchased from [mortgage-backed securities] trusts cure or pay off; however, our cure rate has declined in recent periods and may decline further.”
A cure rate, which pertains to a pool of delinquent mortgages, is the percentage of the pool that’s brought up to date or repaid. In the first case, for example, a borrower makes missed payments and thereby brings the loan up to date. In the second instance, the borrower pays off the mortgage in full, thereby canceling the loan.
During the call, analysts repeatedly pressed Fannie Mae CFO Stephen Swad and divisional CFO Eric Schuppenhauer to reveal the numerical percentage represented by the word majority. Armed with that percentage, analysts could plug the ratio into forecasting models to better predict Fannie Mae’s future prospects based on how many bad loans the company expects will cure, several of the callers noted.
The extra scrutiny by analysts is understandable. Fannie Mae has only just become current with its regulatory filings following last year’s massive restatement following a $6.3 billion accounting scandal.
Despite the tenacious line of questioning, Swad, Schuppenhauwer, and Fannie Mae’s vice president of investor relations, Mary Lou Christy, managed to dodge the analysts’ queries. They executives reiterated throughout the call that they were sympathetic to the analyst’s cry for more disclosure, and would “try” to work on a more robust presentation for next quarter. The trio repeatedly explained that they wouldn’t disclose any new information beyond what was released in the quarterly statement, which comprised hundreds of pages.
The Fannie Mae executives were, however, eager to field questions about two accounting policies that caused investor confusion when the lender issued its third-quarter results on November 9. The first issue concerned an income statement line item known as “losses on certain guaranty contracts,” also known as “day one losses,” which is linked to the fees Fannie Mae collects on mortgages.
The second policy focuses on a standard issued by the American Institute of Certified Public Accountants that is known as Statement of Position 03-3. The standard governs how banks and other financial institutions must account for loss allowances tied to purchases of delinquent loans.
Fannie buys the delinquent loans on a regular basis and works with borrowers to modify loan terms so that the homeowner will be more likely to make payments. Buying bad loans and making modifications “are core to our business,” explained Swad on the call.
Regarding the company’s accounting policy on day one losses, the Fannie Mae finance chief explained that Fannie Mae records a loss on the day the mortgage is bought if the guaranty has a negative fair value. If the guaranty has a positive fair value, the company records a deferred gain — that is, a gain that’s recognized over the life of the loan. For the first nine months of the year, Fannie Mae recognized $1 billion worth of day one losses, up $200 billion during the same period last year. Swad blamed the credit crunch and depressed home prices for the tremendous jump.
The impact of SOP 03-3 on the company’s income statement was less severe. Fannie Mae recorded $113 million worth of charges for the first three quarters, double last year’s $56 million for the same period. Under SOP 03-3, a company records a delinquent loan at the lower of the purchase price or fair value.
If the fair value is less than the purchase price, an immediate charge is taken against a reserve set up for guaranty losses. The charge is equal to the difference between what it paid for the loan and the fair value. “Effectively, we are pulling forward losses before they are realized,” added Swad.
Overall, Fannie Mae’s net revenue for the first three quarters declined year-over-year from $1.9 billion to $1.5 billion. At the same time, mortgage-fee income rose by $482 million because of growth in the number of loans the lender holds, increases in the guaranty fees, and the amortization of losses on the guaranty contracts.
The company’s stock price fell following the announcement, from its opening price on Friday of $44 to a close of $40.69. At midday on Monday the stock was trading at $38. Fannie Mae also announced on Friday that it priced $500 million of preferred stock at $25 per share.