Fannie Mae upbeat despite dip in profits.

AS rew-online.com reported online last week, Fannie Mac, the nation's largest issuer of mortgage-backed securities, released its yearly 10K filing on Thursday.

Coming amidst turmoil in the securitized debt market, the report showed a significant drop in the company's net income as a result of the nation's declining residential real estate market and also due to the cost of administrative reforms that the company completed in the wake of its accounting scandal in 2005.

The 10-K filing showed that Fannie Mac's 2006 earnings dropped to $4.1 billion from $6.3 billion in 2005, largely as a result of eroding home prices that the company said would likely continue for the remainder of this year and accelerate in 2008.

In a written statement, the company stated that the shrinking spread between its borrowing costs and the yield on the bonds that it issues was responsible for the decline in income. The reason for this is because sinking home values, which the company said was especially pronounced in the Midwest, have caused the loan to value ratios for the debt that the company securitizes to consequently rise, requiring it to sell the bonds for less in order to compensate for the risk and attract investors.

Fannie Mac's administrative expenses also jumped by almost $1 billion to $3.1 billion for the year, an increase that the company said paid for the overhaul of its system of internal controls and to establish better governance so that it can avoid future accounting problems and conduct its financial reporting in a timely fashion. Thursday's filing had been delayed and came after an internal audit and months of sorting through its reporting problems.

On Thursday during a company conference call with investors and analysts, Fannie Mac's president and CEO Daniel Mudd was optimistic about the company's performance in 2007 due to its limited exposure to subprime loans and what he described as a shift in demand among investors for the type of fixed rate mortgages that Fannie Mae has traditionally specialized in.

But Mudd also predicted that housing prices will fall on average nationally, by 2% this year and 4% next year, which could continue to put the squeeze on the spread between the company's borrowing costs and the rate it can yield on the bonds that it issues.

UBS issued a report on Fannie May after Thursday's conference call giving the company's stock a buy rating.