Fannie: Sun will come out tomorrow

NEW YORK (Fortune) -- Fannie Mae is betting its bulging rainy-day fund will see it through the housing storm. But the mortgage giant's forecasting record doesn't inspire much confidence.

Fannie Mae (FNM, Fortune 500) posted its fourth straight quarterly loss Friday, as the company added $3.7 billion to its reserve for future credit losses. All told, Fannie's credit expense - reflecting reserve additions plus loan charge-offs and foreclosure costs - jumped tenfold in the second quarter, to $5.3 billion from $518 million a year earlier.

CEO Dan Mudd said Friday the company is managing its way through "the 99th year of a 100-year storm." He didn't venture a guess when the housing crisis might end, but Fannie did say it expects nationwide house-price declines to hit the upper end of its previous estimate of 15%-19%.

Yet even with home prices continuing to tumble and foreclosures doubling year-ago levels in some hard-hit states, Fannie says it believes its credit costs should peak this year.

Finance chief Stephen Swad said the company believes the nearly $8 billion Fannie has added to loan-loss reserves over the past year should allow its earnings to start to recover in 2009 - even if defaults and foreclosures continue to rise, as the company expects.

If Swad's right, shareholders would get some needed relief. They've seen their investment shed three-quarters of its value amid questions about the company's ability to weather the housing storm.

Shares in Fannie and its sibling Freddie Mac (FRE, Fortune 500) plunged to 17-year lows last month, forcing the government to pledge its support for the companies. The stocks then recovered. But Fannie shares tumbled for the third straight day Friday, dropping 9%. They're off 23% for the week.

Fannie and Freddie were created by Congress to make mortgage money more easily available, and they now guarantee or directly hold half the value of U.S. home mortgage debt.

Given Fannie's failure to substantially build reserves last year, as the mortgage meltdown got under way, the prediction that credit costs will wane in 2009 raised eyebrows.

"You have to be a forensic accountant with a crystal ball to say that," says Westwood Capital managing director Len Blum. He believes Fannie and Freddie are too thinly capitalized to survive the collapse of the housing market without goverment help.

Fannie said Friday that its current credit-loss estimates reflect 18 to 24 months of future expected defaults, and that its current credit loss reserve, at $8.9 billion, is equivalent to 31 basis points, or hundredths of a percentage point, on its $2.9 trillion guaranty book of business. The company is currently forecasting credit losses of 23 to 26 basis points for 2008, and more in 2009.

Blum concedes that Fannie's forecast could be correct, but he questions the decision to make that call now. After all, at the end of 2007 Fannie was predicting that 2008 credit losses would be 11 to 15 basis points. The company increased that projection after the first quarter, to 13 to 17 basis points, and then notched the number substantially higher again Friday. Fannie says its historical loss range is around 4 to 6 basis points.

Swad says the sharp rise in the company's credit loss expectations reflects soaring losses on its $307 billion Alt-A book. Alt-A loans are those made to borrowers who have decent credit histories but, in many cases, don't provide full documentation.

Fannie said half its second-quarter credit losses came out of the Alt-A book, and nearly half of that came from California, Florida, Nevada and Arizona, where prices have been in free fall.

Fannie's comments echo those made Wednesday by executives at Freddie Mac, which said it too believes its credit costs are being front-loaded as the company builds reserves. But unlike Fannie, Freddie declined to offer any view as to when house-price declines or credit costs might level off, saying previous forecasts hadn't been accurate.

Blum says that with all the uncertainty surrounding the companies' business - their fortunes are affected not only by house prices but also by unemployment and interest rates, both of which have been rising in recent months - Fannie should have steered clear of the peak-cost issue in the name of "managing expectations."

But as the past year has reminded investors, Fannie hasn't been very good at that.