February 27 2008: 1:48 PM EST
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Fannie, Freddie get mortgage relief

Government lifts cap on the amount of mortgages the lenders can hold, overshadowing news of Fannie's heavy losses.

Colin Barr, senior writer

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Fannie Mae and Freddie Mac are no longer limited in the amount of mortgages they buy - possibly providing some relief to the housing crunch.
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NEW YORK (Fortune) -- Fannie Mae and Freddie Mac shares soared as much as 16 percent Wednesday after the government-sponsored lenders' regulator removed limits on the growth of the companies' mortgage portfolios.

The news, which could free the companies to become more active in buying mortgages amid a sharp decline in the housing market and a slowdown in the secondary markets for mortgage-related securities, overshadowed the bigger-than-expected fourth-quarter loss that Fannie Mae (FNM) reported earlier in the day. Fannie shares fell as much as 8 percent in early trading Wednesday before rallying on the regulatory move.

James Lockhart, head of the Office of Federal Housing Enterprise Oversight, said he would lift the firms' mortgage caps Saturday. He cited the progress both Fannie and Freddie (FRE, Fortune 500) have made in putting years of accounting problems behind them.

"Fannie Mae published its timely, audited financial statement for 2007 today and Freddie Mac anticipates publishing its statement tomorrow," Lockhart said in a midmorning statement. "These steps constitute an important milestone in remediation of their respective operational and control weaknesses that led to multi-year periods when neither company released timely, audited financial statements."

Lockhart also said OFHEO will discuss reducing capital requirements at the companies. Since both Fannie and Freddie were found earlier this decade to have been manipulating their accounting to smooth earnings growth and boost management bonuses, OFHEO has been requiring that they hold 30 percent more capital in a bid to cushion against future losses.

But with house prices falling and private investors having fled the market for mortgage securities, many legislators have been advocating an expanded role for Fannie and Freddie in buying mortgages. They argue that freeing the companies to do so will help to stabilize the housing market and reduce the possibility of a shock to the economy.

The companies' portfolios were capped two years ago at $727 billion for Fannie and $713 billion for Freddie. In September, OFHEO loosened the limits slightly, to $735 billion for each company. Now there is no cap.

Investors cheered the prospect of renewed portfolio growth at the companies -despite the stark commentary on the housing market in Fannie Mae's annual results.

Fannie lost $3.56 billion, or $3.80 a share, for the quarter ended Dec. 31, reversing the year-ago profit of $604 million, or 49 cents a share. The latest-quarter loss reflected a $3.2 billion writedown of the value of Fannie's credit derivatives portfolio, which the firm uses to hedge against interest rate risk on its mortgage holdings, and a $2.8 billion provision for credit losses, which are rising as house prices fall and the economy slows.

Analysts had been anticipating a poor quarter, with Goldman Sachs and Merrill Lynch downgrading the stock to sell from neutral in recent days. But the size of Fannie's fourth-quarter loss exceeded even skeptics' estimates. Goldman, for instance, had been forecasting a fourth-quarter loss of $1.75 a share at Fannie.

Unlike most public companies, which publish their quarterly financial results on their Web sites and issue press releases through wire services, Fannie made its quarterly numbers available at the end of a 98-page appendix to its 162-page annual report, which was filed Wednesday morning with the Securities and Exchange Commission. The filing indicates that Fannie expects to endure more losses in the coming year.

"We are experiencing high serious delinquency rates and credit losses across our conventional single-family mortgage credit book of business, especially for loans to borrowers with low credit scores and loans with high loan-to-value ('LTV') ratios," Fannie writes on page 24 of its 10-K filing. "We expect these trends to continue and that we will experience increased delinquencies and credit losses in 2008 as compared with 2007." Fannie says 2008 losses could worse if the economy heads into recession.

Fannie's poor numbers suggest Freddie's fourth-quarter report Thursday morning will be ugly as well. Analysts on average expect Freddie to announce losses of $2.34 a share, although Goldman expects an even steeper loss of $3.70 a share.

For now, with the government stepping in to ease the housing market's pain, investors might not care. To top of page