Fannie Mae and Freddie Mac, which have reported record profits after a taxpayer bailout, are ignoring billions of dollars in potential losses on overdue loans as they take three years to adopt a new accounting system, a government auditor said in a letter made public today.
The accounting change should be made immediately and could have a material impact on the companies’ finances, according to the Aug. 5 letter to Federal Housing Finance Agency acting director Edward J. DeMarco from Steve Linick, the regulator’s inspector general.
“Three years appears to be an inordinately long period,” Linick wrote in the letter posted on his office’s website today.
The critique may cast doubt on the strength of the recent rebound reported by the two government-sponsored enterprises. Both companies, which were seized by regulators in 2008 to avert collapse, have posted better quarterly profits as the housing market rebounded and they set aside less money to cover losses.
“A substantial percentage of the GSEs’ recent earnings and the subsequent dividend paid to Treasury was a result of decreasing loan-loss reserves,” said Tim Rood, a former Fannie Mae (FNMA:US) executive and now managing director at Collingwood Group LLC, a financial services consulting firm based in Washington. “If the new accounting standard being imposed on them stopped or slowed the release of those reserves, it would have a direct and negative effect on the amount of dividend payments.”
Fannie Mae and Freddie Mac buy mortgages from lenders and package them into securities on which they guarantee principal and interest payments. The FHFA, which oversees Washington-based Fannie Mae and McLean, Virginia-based Freddie Mac, ordered the companies in April 2012 to start writing off all loans delinquent for at least 180 days, a standard practice for regulated financial institutions.
The companies previously hadn’t charged off all loans in that category. FHFA later gave the companies until January 2015 to comply.
The longer timeline is necessary to accommodate “considerable changes to systems and operations that could take time to complete in a safe, sound and well-controlled manner,” FHFA deputy director Jon Greenlee said in an Aug. 9 letter responding to Linick.
“Our objective is to do anything like this in a safe, sound and well controlled way because if you try to do something significant too quickly you could lose control of your accounting systems or what you’re trying to accomplish and that’s obviously not something anybody wants to happen,” Greenlee said in an interview today.
Because they’re not charging off some loans more than 180 days overdue, Fannie Mae and Freddie Mac (FMCC:US) aren’t setting aside reserves against those losses, Linick said.
The companies have mentioned the coming accounting change in public disclosures (FNMA:US) filed with the Securities and Exchange Commission, without saying how big any losses might be.
In a May 2 meeting, Greenlee told the Office of the Inspector General the change “could potentially require them to charge of billions of additional dollars related to loans classified as ‘loss,’” Linick wrote in the letter.
Fannie Mae officials dispute Linick’s assertion that the accounting change would materially affect its earnings.
“The guidance FHFA has issued would change our methodology for charging off loans, but would not materially change our results,” Andrew Wilson, a Fannie Mae spokesman said in an e-mail. “We continue to have ongoing discussions with FHFA about how to implement its guidance.”
Brad German, a spokesman for Freddie Mac, said in an e-mail that his company is “working on several technological enhancement projects outlined in the comprehensive implementation plan we sent FHFA back on January 31, 2013.”
Fannie Mae and Freddie Mac will be required to start providing quarterly estimates of the financial impact of the accounting change to FHFA and the Office of the Inspector General, Greenlee said. The agency also expects the companies to start reporting those estimates in their public financial statements, he said.
The two companies have received $187.5 billion in taxpayer aid since 2008. They’ve sent Treasury dividends totaling $132 billion, including $76 billion this year alone. Those payments count as a return on the government’s investment, not as a repayment of the aid.
President Barack Obama has called for the firms to be wound down and replaced by a government reinsurer that would cover mortgage losses in catastrophic circumstances. Private capital would take the initial losses.
Congress is also working on legislation that would liquidate them. In the Senate, Tennessee Republican Bob Corker and Virginia Democrat Mark Warner introduced a bill that would require private capital to take at least 10 percent of the first losses on mortgage securities. The government would step in with more aid during a financial catastrophe.
Republicans in the House of Representatives led by Jeb Hensarling of Texas are working on a bill that would eliminate Fannie Mae and Freddie Mac and limit government involvement in housing finance to the mortgage insurance provided by the Federal Housing Administration.
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