Government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac are failing to disclose billions of dollars in losses from delinquent mortgages they carry by delaying the implementation of new accounting measures that would require them to write off the more delinquent loans, the Office of the Inspector General (OIG) said in a letter to the Federal Housing Finance Agency (FHFA) released Monday.
As explained in the letter written by Inspector General Steve Linick to FHFA Acting Director Edward J. DeMarco, the FHFA allowed the GSEs to postpone implementation of the accounting measures until Jan. 1, 2015, due mainly to technological and process challenges. That delay, in turn, allowed the GSEs to postpone the reporting of losses resulting from delinquencies by way of a quarterly advisory bulletin. As per federal regulations, the GSEs, along with the other Federal Home Loan Banks (FHLBs), are required to write off losses from all loans that are more than 180 days delinquent.
The postponement of the implementation of the new accounting measures, however, means that not only have the GSEs not been reporting those losses, but they also have not been shoring up their reserves subsequent to the risk associated with the delinquent loans. As such, they are not engaging in proper risk management, as per the FHFA's guidelines, nor are they properly classifying the loans and related level of risk to government regulators, Linick's letter to DeMarco states.
‘Classification of loans according to risk characteristics is a critical factor considered by financial regulators to evaluate a financial institution's safety and soundness,’ Linick wrote in the letter. ‘Given that a majority of their assets are concentrated in loans, Fannie Mae and Freddie Mac consider accounting for loan loss reserves to be an accounting policy critical to the understanding of their financial statements.’
The goal of the new accounting method is to provide regulators and the public with greater insight into the GSEs' financial health. Following the government bailouts and subsequent takeover of Fannie and Freddie resulting from financial crisis, both entities returned to profitability last year.
‘The FHFA expects that the [GSEs] will deal timely with loan delinquencies,’ Linick's letter states. ‘When a loan is 180 days delinquent, our review of the data indicates that under most circumstances, the likelihood of full repayment is remote.’
Because accounting and classification of the delinquent loan data is such an important aspect of risk management for the GSEs, the OIG is urging the FHFA to require Fannie, Freddie and the FHLBs to start reporting the estimated impact on their financial statements from the delinquencies immediately, and ‘thereafter on a quarterly basis.’
In essence, the OIG is telling the FHFA that implementation of the new accounting methods is taking too long.
‘FHFA examination staff identified no later than January 2012 a significant risk management issue relating to loan loss reserves, with potentially significant consequences for Fannie Mae and Freddie Mac, concerning treatment of loans delinquent more than 180 days,’ Linick's letter states. ‘Three years appears to be an inordinately long period to fully implement the advisory bulletin. We have concerns about the delay in its implementation until 2015.’
In a written response to Linick's letter, Jon D. Greenlee, deputy director of the FHFA's division of enterprise regulation, said the FHFA would comply with the OIG's request to start reporting estimates on losses to regulators immediately. In addition, the FHFA would start providing written explanations as to why implementation of the new accounting standards was being delayed.
‘FHFA believes that the current timeline for the [GSEs'] implementation of [the new accounting methods] is appropriate to accomplish the guidance's stated objective,’ Greenlee's letter states. ‘Like all regulators of large, complex financial institutions, FHFA recognizes that changes in a significant policy, such as [the new accounting methods], require considerable changes to systems and operations that could take time to complete in a safe, sound and well-controlled manner.’
Greenlee's response also explains the challenges the FHFA and the GSEs faced in implementing the new accounting methods and why it has taken so long for them to be developed and put into use.
The change in the classification potentially could require the GSEs to ‘charge off billions of additional dollars related to loans,’ Linick's letter states.
Fannie Mae reported net income of $10.1 billion for the second quarter and said it would send a $10.2 billion dividend payment to the U.S. Treasury for its federal aid. It was the sixth straight profitable quarter for the company, which, for comparison purposes, reported a $5.1 billion profit for the second quarter of 2012.
Freddie Mac, meanwhile, posted net income of $5 billion for the second quarter and said it would make a $4.4 billion dividend payment to the Treasury.