Mortgage finance giant Fannie Mae (FNM) posted a larger-than-expected second quarter loss on Friday morning, as credit costs tied to an increasing number of defaulted mortgages helped eat away at the GSE's bottom line, and the company reserved aggressively for expected default activity 18 to 24 months out from now. As a result, the company said it would cut its common stock dividend from $.35 per share to $.05 per share, a move that it said would preserve $1.9 billion in capital. The company also said it will move to reduce operating costs by 10 percent by the end of next year, although executives did not provide further details on any staffing cuts that may be in the offing; the company has been beefing up its staff in default management and REO sales as of late, and said Friday that it will open local offices in both California and Florida to help it better manage swelling foreclosed property inventory in both states. Fannie absorbed $5.3 billion in credit-related expenses during the second quarter, including $3.7 billion added to the company's loss reserves; rising credit costs more than swamped an increase in revenue, which reached $4.0 billion for the quarter, up 5 percent from the first quarter and 46 percent from Q2. Company executives said they expect credit costs to continue to rise -- and sharply, too -- throughout the balance of this year, while revenues in the third and fourth quarters of 2008 should remain flat; taken together, this clearly suggests that Fannie is planning to see large losses over the rest of this year. Which, of course, is part of the reason the GSE has raised more than $14 billion in fresh capital over the past three quarters. And, indeed, Fannie CEO Daniel Mudd acknowledged as much about the road ahead in a conference call with investors. "There is progress," he said, "but we have a long way to go." Mudd said that the company had bumped up its expected credit losses for 2008 to a range of 23 to 26 basis points, a huge jump from the 13 to 17 basis point range it provided in the first quarter earnings report; to understand just how large this jump really is, consider that annualized credit losses at Fannie Mae amounted to 15 basis points in the first half of 2008. To get into the 23 basis point range for the full year, credit losses will need to run at a minimum of double the losses booked in the first half of the year, or at an annualized 31 to 36.5 basis points. Further, Fannie said that is is expecting credit losses to mount further in 2009, even if loss provisioning activity slows (as expected) relative to this year's pace. Driving estimates for credit costs aren't just increasing defaults, but also increasing losses on those defaults, Fannie said -- loss severity rose to 23 percent in Q2, up from 19 percent in the first quarter; and Mudd noted in the call that severity jumped even further, to 27 basis points, in July. Driving much of the losses in the mortgage books are ill-timed investments into Alt-A mortgages, which represent just 11 percent of the mortgage book at Fannie but drove 50 percent of Q2 losses. Officials said on a call with analysts said that they believe they have more than sufficient capital to weather 2008, but refused to speculate on where the company's capital levels will be when 2009 rolls around. For more information, visit Disclosure: No positions in FNM when story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.