Fannie Mae, the nation's largest source of home loan funding, increased its holdings of risky subprime loans in 2006 while its profits fell that year, the company said on Thursday in a long-delayed report.

As the U.S. volume of higher-risk subprime loans increased from 2003 through mid-2006, Fannie Mae said its purchase and securitization of loans that pose a higher credit risk ... also increased. It added that its holdings increased to a lesser degree than many other institutions.

Net income at the company fell 36 percent to $4.06 billion last year from $6.35 billion in 2005, the company said in its 2006 annual report filing with the Securities and Exchange Commission.

It attributed the weaker earnings to increased administrative costs and changes in long-term interest rates that affect the value of its loan assets. Fannie's quarterly income can swing as interest rate changes affect the tendency of homeowners to refinance their mortgages.

The company has not been able to produce timely filings since it was shaken by an accounting scandal in late 2004.

About 12 percent of the company's single-family book of business was higher risk Alt-A mortgages as of the end of June, Fannie Mae said. About 2.2 percent of its book was subprime as of the end of June.

The company said it expects to see higher delinquencies and credit losses this year compared with 2006 and that it faces concentration risk as other mortgage industry companies fail, which should shift business to Fannie Mae.

The company also said that, as of the end of 2006, it had identified eight material weaknesses in its internal control systems and that those weaknesses could harm investor confidence.

Thursday's report showed Fannie had less exposure to high-risk loans than many observers had expected, said Jim Vogel, who tracks the company for FTN Financial in Memphis, Tennessee.

This won't stop those who predict gloom for (Fannie Mae), but should reduce speculation of what 'might' be out there, he said in a note to clients.

Last week, the regulator for Fannie Mae denied its request to expand its mortgage investment portfolio, which is valued at about $722 billion.

Both Fannie and Freddie shares had risen before Friday with the expectation that the regulator, the Office of Federal Housing Enterprise Oversight, might relax those growth caps.

The administration of George W. Bush has said the combined $1.4 trillion investment holdings of the two government-sponsored companies are dangerously bloated and should be curbed.

Mortgage lender Countrywide Financial said on Thursday its would focus on writing loans that could be sold to Fannie and Freddie, leaving the companies in a strong position to weather ongoing market turmoil, an analyst said.

Compared to any other financial institution, Fannie Mae and Freddie Mac look good, said James McGlynn, a portfolio manager with Summit Investment Partners in Southlake, Texas. Countrywide is borrowing from the banks and only going to be making loans going to Fannie Mae and Freddie Mac.

Fannie shares were about 1 percent higher in morning trade, outperforming wider markets.

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