WASHINGTON - Fannie Mae announced Tuesday evening the departure of its two top executives, and its regulator declared the company "significantly undercapitalized."
The company said that Franklin Raines, the chairman and chief executive officer, had retired and Timothy Howard, the vice chairman and chief financial officer, had resigned. The terms of the two executives' departure were not immediately available.
The exits of Mr. Raines and Mr. Howard put an end to speculation that has surrounded the company since the Securities and Exchange Commission said last week it must restate earnings since 2001.
However, the capital classification showed that Fannie still faces many challenges. The Office of Federal Housing Enterprise Oversight said Tuesday evening that Fannie was nearly $3 billion short of its minimum capital requirement of $31.8 billion at the end of the third quarter.
The capital measurement fell short because OFHEO took into account that Fannie must take an estimated $9 billion loss after taxes when it restates earnings. OFHEO said it has directed Fannie to provide it with a capital restoration plan to meet the minimum requirement for core capital and hold the 30% surplus the company had pledged previously.
Effective immediately, the company named board member Stephen B. Ashley the non-executive chairman of the board, and vice chairman and chief operating officer Daniel H. Mudd the interim CEO. Executive vice president Robert Levin will serve as interim CFO, the company said.
Mr. Ashley has been a Fannie board director since 1995 and is a former president of the Mortgage Bankers Association. Prior to joining Fannie in 2000, Mr. Mudd was the president and CEO of GE Capital in Japan.
Fannie also said its audit committee had dismissed its auditor, KPMG LLP, and initiated a search for a new accounting firm.
OFHEO, which three months ago accused the company of purposely manipulating its accounting to smooth earnings, said it welcomed Fannie's change of leadership.
"We are encouraged that the board's announcement signals a new culture and a new direction for Fannie Mae," OFHEO Director Armando Falcon Jr. said in a news release. "OFHEO is working closely with the board to promptly address the elements of a capital restoration plan and other important reforms."
Sources said OFHEO had been prepared to remove Mr. Raines and Mr. Howard if the Fannie board had not acted.
While the executives' departure closes a chapter in the ongoing troubles at Fannie, much remains to be done. Now that it is "significantly undercapitalized," OFHEO has the legal authority to take further actions against the company if it appears unwilling or unable to correct itself. Those powers include the ability to restrict Fannie's growth and activities, and even appoint a conservator.
Fannie must still release its third quarter earnings, and will have to work hard to hold 30% more capital than its minimum requirement by the end of the second quarter of next year. Fannie signed an agreement with OFHEO on Sept. 27 that included the capital provision and other changes the company must make.
Fannie said in its statement Tuesday that it continues to move forward to meet the agreement's terms. It said it has hired independent organizational and compensation consultants, submitted a detailed implementation plan for the agreement, and that board member Donald B. Marron continues to work on the company's capital plan.
"We are mindful of our obligations under the agreement with OFHEO, we are working diligently in cooperation with OFHEO to comply with the agreement, and we are making progress on implementing its terms," board member H. Patrick Swygert said in Fannie's press statement.
The board is also continuing its independent review of the issues raised by OFHEO. The investigation is led by former Sen. Warren Rudman, and is focused on the company's accounting, board oversight and management responsibilities, and executive compensation.OFHEO said that in 1998 Fannie executives improperly deferred $200 million of expenses to meet earnings targets and secure executive bonuses.
In a statement, Mr. Raines did not acknowledge wrongdoing, but said he is retiring because he promised at an Oct. 6 House hearing that he would hold himself responsible for any accounting errors.
"Although, to my knowledge, the company has always made good faith efforts to get its accounting right, the SEC has determined that mistakes were made," Mr. Raines said. "By my early retirement, I have held myself accountable."
Board member Ann Korologos, the presiding director of the non-management members of the board, praised Mr. Raines and Mr. Howard for their "devotion to Fannie Mae and commitment to its mission."
But most observers said the board had little choice but to act. Both executives vigorously defended the company's accounting in the Oct. 6 hearing, and appeared to pin all their hopes on justification from SEC. When the SEC ruled against the company, it left them, and the board, with little maneuvering room. It also left OFHEO with added credibility to demand any changes at the company.
Many had begun to wonder by Tuesday why the company's board appeared reluctant to oust Mr. Raines. One source familiar with the situation said Tuesday that the board might have felt compelled to act once OFHEO said that it would declare the company "significantly undercapitalized."
Rep. Richard Baker, who has led a GSE reform effort for years, said in a news release Tuesday that the board's decision to oust Mr. Raines and Mr. Howard "was entirely necessary."
"I commend OFHEO for insisting on these first steps toward rebuilding trust in the company, and I thank Fannie's board for recognizing their necessity," he said. "Moving forward, I hope Fannie's board will take a long hard look at changing the corporate culture to one that makes a greater effort at managing financial risk than it does at fighting political risk."
