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Fannie, Freddie should recognize bad loan costs immediately: watchdog

A sign in front of the Fannie Mae headquarters is photographed in Washington February 11, 2011. REUTERS/Molly Riley
A sign in front of the Fannie Mae headquarters is photographed in Washington February 11, 2011. REUTERS/Molly Riley

WASHINGTON (Reuters) - Fannie Mae and Freddie Mac are possibly masking billions of dollars in losses because of the level of delinquent home loans they carry, a federal watchdog said on Monday, adding that the companies should immediately be required to recognize the costs of some bad mortgages.

In 2012, the Federal Housing Finance Agency began work on accounting changes to require the two housing finance firms to set aside loan loss reserves for mortgages delinquent at least 180 days. The new standard is set to go into effect in 2015.

In its report released on Monday, the FHFA's inspector general called the timeline for implementation "inordinately long."

The change in the accounting treatment of these delinquent loans potentially could require Fannie and Freddie, which have rebounded to enormous profitability in the past two years as the housing market recovered, to "charge off billions of additional dollars related to loans," the report stated.

The FHFA, which regulates Fannie Mae and Freddie Mac, said in a letter to the FHFA inspector general the two companies are on track to implement the new standards, and expects the companies to start reporting those estimates in their public financial statements. The letter also said the FHFA views the potential losses "to be reasonable."

Fannie Mae and Freddie Mac were seized by the U.S. government in September 2008 as rising mortgage losses threatened them with insolvency. The mortgage companies have cost taxpayers almost $188 billion to stay afloat.

The majority of Fannie Mae and Freddie Mac's losses are a result of guaranteeing mortgages that defaulted during the housing crisis. The companies have reduced their funds reserved to cover potential losses on bad loans due to the strengthening housing sector and higher home prices.

The FHFA said the new accounting methods involve "changes in a significant policy" that required a lengthy implementation period. The regulator consulted with Fannie Mae and Freddie Mac and has allowed the mortgage companies until January 1, 2015, to make all of the adjustments, which will be rolled out in stages.

The inspector general's report, dated August 2, called on the FHFA to require the firms to implement the changes at a faster pace and expressed concern that Fannie Mae and Freddie Mac were not recognizing the potential losses in their public financial statements.

Fannie Mae on August 8 reported a $10.1 billion profit for the second quarter and said it would send a $10.2 billion payment to the U.S. Treasury for its federal aid. It was the sixth straight profitable period for the company and compares with a $5.1 billion profit for the year-earlier quarter.

For the second quarter, Freddie Mac posted its second largest ever quarterly profit, reporting net income of $5 billion, and said it would make a $4.4 billion dividend payment as part of the reimbursement for its rescue aid.

Work on the accounting changes began in April 2012. At that time, Fannie and Freddie were asked by the FHFA to provide an initial implementation plan and to take a closer look at new asset classifications, according to the FHFA's letter.

Fannie and Freddie submitted the implementation plans by October 2012, the letter stated. During that time, FHFA did its own analysis on Fannie and Freddie's 180-day delinquent loans' performance and found the "financial impact to be reasonable."

Both companies have noted the upcoming accounting changes in public filings with the Securities and Exchange Commission, although they have not yet estimated the size of possible losses.

"The guidance FHFA has issued would change our methodology for charging off loans, but would not materially change our results," said Andrew Wilson, a spokesman for Fannie Mae.

Freddie Mac is "making technological enhancements this year," to implement the plan the company sent its regulator, said Brad German, a spokesman for the company.

(Reporting by Margaret Chadbourn; Editing by Leslie Adler and Chris Reese)

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