Aug. 8 (Bloomberg) -- Fannie Mae, the largest U.S. mortgage- finance company, cut its dividend 86 percent after posting a loss that was more than three times analysts' estimates and said the worst housing slump since the Great Depression is deepening.

Fannie dropped as much as 19 percent in New York Stock Exchange trading after reporting a second-quarter loss of $2.51 a share, compared with the 72-cent average estimate of 10 analysts in a Bloomberg survey. The common-stock dividend will be cut to 5 cents from 35 cents a share, Washington-based Fannie said today.

Fannie, which owns or insures about 25 percent of all U.S. mortgages, said credit losses rose 66 percent to $5.3 billion as delinquencies rose. Chief Executive Officer Daniel Mudd forecast a ``significant'' increase in reserves for the rest of the year as the housing market deteriorates. Fannie's results, combined with a loss by Freddie Mac that was also wider than analysts anticipated, may boost the need for Treasury Secretary Henry Paulson's bailout plan announced last month.

The results ``increase the probability of the government stepping in,'' said Paul Miller, an analyst at Friedman, Billings, Ramsey & Co. in Arlington, Virginia, who has an ``underperform'' rating on both companies. ``Neither of these companies have properly provisioned for what we're heading into. This thing is going to get worse and last longer and deeper than they originally thought.''

`More Pronounced'

Fannie and Freddie plunged more than 80 percent in New York trading this year on concern they may not have enough capital to withstand record foreclosures on the $5.2 trillion of mortgages they own and guarantee. Both companies will need to raise as much as $15 billion, Miller said.

``Volatility and disruptions in the capital markets became even more pronounced in July,'' Mudd, 49, said in the statement. ``In addition, credit performance has continued to deteriorate and, based on our experience in July, we anticipate further increases in our combined loss reserves.''

Fannie's net loss was $2.3 billion, or $2.54 a share, including a $476 million tax gain. That compares with net income of $1.95 billion, or $1.88 a share, in the same quarter a year ago.

Provisions for future credit losses rose $3.7 billion. Fannie almost doubled its projections for the company's 2008 credit-loss ratio, which measures losses relative to the size of the company's holdings, to a range of 23 basis points to 26 basis points, up from 13 basis points to 17 basis points. That ratio will increase further in 2009, Fannie said in the statement. Each basis point is worth almost $280 million, according to Credit Suisse Group's Moshe Orenbuch, the top-ranked analyst covering the company.

Consuming Capital

``Credit continues to worsen and that's the driver,'' Credit Suisse's Orenbuch said. Orenbuch, based in New York, has an ``underperform'' rating on Fannie and Freddie. ``It's probably going to be difficult for them to get profitable during 2008 and they're going to continue to consume capital over the next several quarters.''

Fannie said it is building reserves in anticipation of expenses it will incur in 2009 and 2010. Credit-related expenses will peak this year, though will also be ``significant'' in 2009, Fannie said.

Fannie, down 27 percent since Freddie's earnings release on Aug. 6, declined 47 cents to $9.48 at 10:23 a.m. in New York Stock Exchange composite trading after falling as low as $8.10. McLean, Virginia-based Freddie fell 27 percent in two days and declined 14 cents to $6.03.

Raising Capital

Mudd has raised $14.4 billion since late last year and reduced the dividend from 50 cents since December. The company said in May the dividend would be chopped to 25 cents this quarter and deepened the cut to 5 cents today, preserving $1.9 billion of capital through 2009. Mudd still failed to quell concerns that the company is short of capital. As worries escalated, he dispatched executives to Asia to calm investors. Fannie's core capital was $47 billion at the end of the quarter, up from $42.7 billion in March, after the company sold $7.4 billion of preferred stock.

In an effort to shore up capital, Fannie said today it will reduce operating costs 10 percent by 2009. Fannie will also stop buying Alt-A loans, which rank between prime and subprime, by yearend. Alt-A loans, often giving to borrowers who don't provide full documentation, are among investments that caused more than 60 percent of the company's losses. The company also plans to double an upfront fee for guaranteeing mortgages to 50 basis points.

Fannie and Freddie, government-chartered enterprises created to boost mortgage financing, own or guarantee 42 percent of the $12 trillion of U.S. home loans outstanding. They make money by holding mortgage assets that yield more than their debt costs, and by guaranteeing bonds they create out of loans.

`Propitious Time'

Freddie CEO Richard Syron, 64, this week said the company is waiting for a more ``propitious time'' to sell the $5.5 billion in stock it had agreed to offer in May. Freddie said it will cut its dividend at least 80 percent and may slow purchases of mortgages to shore up capital.

The companies are stumbling just as the government is leaning on them to revive the housing market and keep the economy out of recession.

Almost one in every 10 mortgages in the U.S. was in trouble during the first quarter, the highest in records dating to 1979, according to the Mortgage Bankers Association in Washington. Delinquencies, or home loans with payments 30 days or more overdue, rose to 6.35 percent of outstanding mortgages and the share of homes in foreclosure rose to 2.47 percent.

Paulson last month received authority for his plan to buy unlimited equity stakes in the companies and extend them financing if needed to help bolster confidence in the companies.

`Based on Faith'

Bill Gross, manager of the world's biggest bond fund and Pacific Investment Management Co., said the Treasury will probably be forced to buy as much as $30 billion of preferred shares in both Fannie Mae and Freddie Mac.

Government intervention will come quickly if the companies can't issue new debt to pay off obligations as they mature, Friedman Billings's Miller said.

``It's all based on faith, and who knows when that faith walks away,'' Miller said. ``It can happen within 12 hours. I don't think it would be good for anybody if we go down that path. The best solution is if the companies raise capital now.''

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net

Last Updated: August 8, 2008 10:32 EDT