May 6 (Bloomberg) -- Fannie Mae's regulator will reduce restrictions on the largest financer of home loans, even after a wider-than-expected loss forced the company to raise capital and reduce its dividend.

Fannie Mae rose 8.9 percent after the Office of Federal Housing Enterprise Oversight said it will lower surplus capital requirements to 15 percent from 20 percent to allow the company to buy and guarantee more mortgages, its biggest source of profit. Washington-based Fannie Mae reported a $2.19 billion loss, cut the dividend for the second time in six months and said it plans to raise $6 billion to increase capital.

Ofheo is giving Fannie Mae and Freddie Mac more freedom to boost their mortgage portfolios and alleviate the worst housing slump since the Great Depression. The companies last quarter accounted for 81 percent of the home-loan market that other firms fled. The money raised will enable Fannie Mae to ``emerge from this crisis'' in a stronger position, Chief Executive Officer Daniel Mudd said.

``With a weak housing market, for God's sake, we need Fannie Mae and Freddie Mac to work,'' said Andrew Parmentier, a managing director at Friedman Billings Ramsey & Co. in Arlington, Virginia.

The first-quarter net loss was $2.57 a share, Fannie Mae said in a statement today. Analysts were anticipating a loss of 64 cents, the average of 12 estimates from a Bloomberg survey.

Losses to Increase

Credit and derivative losses rose fivefold to $8.9 billion, Fannie Mae said in a statement. The government-chartered company cut its dividend to 25 cents after lowering it to 35 cents from 50 cents last year. Fannie Mae will begin a $4 billion sale of common and convertible preferred shares today.

Fannie Mae told analysts to expect bigger credit losses in 2009 and said it sees U.S. home prices falling 7 percent to 9 percent this year, up from its previous estimate of 5 percent to 7 percent. Executives see U.S. home prices eventually tumbling by an average of as much as 19 percent before starting to recover.

``There are certain things that we can't control, like home prices and the overall condition of the economy, and until they improve, they will be a drag on our old book,'' Chief Business Operator Rob Levin told analysts during a conference call today.

Deteriorating Fast

``They are now starting to realize the fact that their credit losses will be considerably higher than they were in 2007,'' said Ajay Rajadhyaksha, head of fixed-income strategy for Barclays Capital, who is based in New York. ``Things in the housing and credit markets are deteriorating very fast.''

Ofheo lifted its consent order with Fannie Mae, imposed in 2006 after the company admitted to $6.3 billion in accounting errors. The regulator's willingness to free Fannie Mae from restrictions and allow it to buy more mortgages shows lawmakers aren't keeping up with the housing market slump, said Jim Vogel, head of agency debt research at FTN Financial Group in Memphis, Tennessee.

``Some of the things Fannie said today and experienced in the first quarter tells Washington they've fallen farther behind,'' Vogel said. ``The problems are outpacing Washington's programs.''

Limits Lowered

Congress created Fannie Mae and Freddie Mac to increase mortgage financing. The companies, which traditionally have owned or guaranteed about 40 percent of the $12 trillion in U.S. home loans, increased their share after the housing slump forced other firms out of the market.

Fannie Mae and Freddie Mac profit by holding mortgage assets that yield more than their debt costs, and from fees charged to guarantee bonds they create out of loans. Ofheo will lower its capital requirements once the money is raised. The limit may be reduced to 10 percent by September if Fannie Mae continues to retain excess capital, the company said.

The regulator lifted limits on the size of Fannie Mae's and Freddie Mac's investment portfolios this year, ending more than two years of restrictions. Ofheo Director James Lockhart said at the time the companies are needed to bolster the mortgage market.

``Right now we are in the belly of the cycle,'' Mudd said on a conference call with investors. ``The initial period of high volatility and big shocks in the marketplace seems to be dissipating. The capital markets are recovering balance and spreads are returning back to normal relationships.''

Shares Rise

Fannie Mae rose $2.52 to $30.81 in New York Stock Exchange composite trading. The shares have plunged 50 percent in the past year. Freddie Mac, down 59 percent, rose $1.81 to $27.33 today.

``Ultimately these companies when we get through this are probably going to earn something like $5 to $8 a share,'' Gary Gordon, an analyst at Portales Partners LLC in New York, said. ``As a long-run investment, I think they're good buys, but it's going to be a while to fully realize that value and certainly bumpy along the way.''

Mudd, 49, and Freddie Mac CEO Richard Syron, 64, agreed in March to raise capital after Ofheo allowed the companies to add more assets in an effort to pump cash into the housing market.

Fannie Mae sold $7 billion of preferred stock in December. Financial firms raised more than $234 billion after reporting more than $318 billion of losses and asset writedowns stemming from the U.S. subprime mortgage-market collapse.

Loss Estimates Increased

Fannie Mae boosted estimates for credit losses this year to a range of 13 basis points to 17 basis points, up from a range of 11 basis points to 15 basis points. Every basis point, or 0.01 percentage point, is equivalent to 15 cents of earnings a share, according to Morgan Stanley analysts.

The fair value of assets dropped to $12.2 billion last quarter from $35.8 billion in December. Shareholder equity, which measures how much money would be left to stockholders after Fannie Mae pays all its bills, dropped to less than zero for common stockholders for the first time in at least 15 years, from $20.5 billion in the fourth quarter.

Fannie Mae listed $56.1 billion in so-called Level 3 assets, a category which indicates the holdings are so illiquid that they can only be priced using the firm's own valuation models.

To contact the reporter on this story: Dawn Kopecki in Washington at dkopecki@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net

Last Updated: May 6, 2008 17:37 EDT