Watchdog: Fannie and Freddie should be required to recognize bad mortgages 'immediately'

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

The report, written by the inspector general for the Federal Housing Finance Agency and reviewed by Reuters, said the FHFA's timeframe for mortgage finance companies Fannie and Freddie to have up to two years to recognize the cost of mortgages delinquent at least 180 days was "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 inspector general's report stated.

The FHFA, which regulates Fannie Mae and Freddie Mac, said the two are on track to implement the new standards within the next two years, and in a letter sent to the inspector general said it 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. Fannie and Freddie have reduced their funds reserved to cover potential losses on bad loans due to the strengthening housing sector and higher home prices.

The FHFA noted the new accounting methods would involve "changes in a significant policy," and as a result require 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 office said in the report, dated August 2, that Fannie and Freddie have not publicly disclosed the accounting changes.

The report called on the FHFA to require Fannie and Freddie to conduct the changes at a faster pace, with the inspector general primarily concerned with loss estimates that are realized in Fannie and Freddie's 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.

Both companies 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."

(Reporting by Margaret Chadbourn; Editing by Leslie Adler)