Fannie Mae will face a future of higher costs and slower revenue growth as the expense of both ongoing investigations and new regulations diminish its profit, according to Wall Street and ratings agency analysts. This will likely diminish the ability of Fannie’s stock – long a favorite of both value and growth-stock investors for its predictable earnings – to continue its decade-long history of price appreciation and dividend growth.

One source of potential woe for Fannie Mae’s shareholders is the “virtual certainty” of a cut in the company’s long-term debt ratings, said Egan-Jones Ratings co-founder Sean Egan. “The company is simply not a triple-A company. When Moody’s Investors Services and Standard & Poor’s wake up to this, the market is going to change Fannie’s business model in a minute,” he said. Fannie – which he cut to single-A four months ago – would have to pay an additional 60 basis points in interest expense annually, or about $548 million extra on its $913 billion portfolio.

For the last two decades, Fannie Mae has relied on its ability to issue billions of dollars annually in debt with interest rates comparable to Treasury debt, buy residential mortgages and loans from banks and thrifts, and profit on the difference between the two.

Once, in the early 1980s, Fannie had to be bailed out by the Treasury department when high borrowing costs caused the company to lose $1 million a day.

Complying with its regulator – the Office of Federal Housing Enterprise Oversight, or Ofheo – and its demand for an additional $10 billion in equity capital is likely to cost Fannie Mae a bundle more, Mr. Egan said. Assuming that the company could sell additional preferred stock at last week’s terms, he predicted Fannie would incur about $310 million more in dividend expenses each year.

If interest rates rise, as the Federal Reserve’s December 14 meeting notes indicate they will, Fannie’s expenses will increase further.

Mr. Egan, who first attracted attention by lowering his ratings on World-Com and Enron debt several months prior to S &P and Moody’s, said Fannie Mae shareholders have long benefited from the benign neglect of an indifferent Congress and a weak regulator. The company has been able to invest much more of its equity capital – and earn interest income on it – than its financial sector competitors, he said. “A single-A rated bank has to maintain equity capital equal to 8% of assets; Fannie has had to put aside just 2%. Everything else they were able to put to work.”

A former consultant to Fannie Mae, Bert Ely, agreed with Mr. Egan’s estimates but added that the case of Fannie’s smaller rival Freddie Mac – which experienced its own regulatory woes two years ago – provided an apt comparison. Freddie was forced to spend more than $200 million to reconfigure its vast network of accounting and financial reporting systems in the wake of being found to have hidden more than $5 billion in profits, he said. “The Ofheo report made clear that Fannie skimped on people and technology when it came to financial reporting and analysis,” he said.

Mr. Ely, who has become a vocal advocate for Fannie Mae and Freddie Mac’s privatization, said that since Fannie’s new accountants, Deloitte Touche, announced that a thorough audit would take more than a year, “the company has some time to get a creditable risk management team in place.” By “creditable,” he meant a risk management team that had no connection to the recently ousted chairman and CEO, Franklin Raines. “Interim CEO Daniel Mudd is probably a decent choice to keep around, but it will take two years to bring in the dozens and dozens of executive and portfolio management ranks necessary to change the culture,” he said.

A former Wall Street research bull, Friedman Billings Ramsey analyst Paul Miller, predicts an entirely different future for Fannie Mae given the likelihood of increased regulation and expanded costs.” The stock has gone from a value play based on earnings potential to a slow growth ‘financial utility,'” he said. To support its stock price and maintain investor interest, he predicted Fannie would be smart to boost its dividend payout to 50% of earnings from its current 30%, to $2.80-$3 from $2.08, said Mr. Miller.

A boost in dividend assumes the company’s new auditors find no new problems, Mr. Miller said. “But here’s the thing: I’m worried about the audit. Given a thorough two years, I’m not sure what they can dig up, and they will have incentive to dig things up,” he said. If more revelations come out, no matter what the company earns, “You could have a sub-$50 stock.”