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Fannie Asset Write-Down Raises Concerns

By Zachary A. Goldfarb
Washington Post Staff Writer
Thursday, October 30, 2008

Mortgage finance giant Fannie Mae said yesterday that a class of assets that had made up a big part of its financial cushion in the months before the government took it over now effectively has no value.

The announcement raises the probability that the government will need to put money into the firm and, experts said, signals that the company does not expect to make a profit in the foreseeable future.

The government took over Fannie Mae and Freddie Mac in early September on concerns that the companies were becoming financially unstable and were unable to play their role supporting the nation's ailing mortgage market.

Analysts had long questioned whether Fannie Mae and Freddie Mac were appropriately counting deferred tax assets as part of their financial cushions, known as capital. These assets are credits toward corporate taxes -- so long as the companies have profits they need to pay taxes on. But Fannie Mae and Freddie Mac have experienced big losses on mortgage bonds they own and guarantee.

Fannie Mae said yesterday that it effectively is writing down "substantially all of the value of the deferred tax asset." At the end of the second quarter, its deferred tax asset was worth $20.6 billion, comprising nearly half its $47 billion in capital.

Several accounting experts said that to write down the deferred tax asset, Fannie Mae had to decide that it probably wouldn't have any taxable income for which to apply the tax credits.

"They're admitting they're not likely to generate profits in the foreseeable future," said Terrence J. Shevlin, professor of accounting at the University of Washington.

Dartmouth accounting professor Richard C. Sansing said Fannie Mae's action does not mean it will never be able to use tax assets -- just that auditors currently believe the company is unlikely to. "The fact that they've written it down doesn't mean it's worthless," he said. "It just means there's more than a 50 percent chance they will never get any use out of it."

Such large write-downs of deferred tax assets are rare but not unheard of. Late last year, General Motors said it was writing down $38.6 billion in deferred tax assets, accounting for much of a $39 billion loss in the third quarter.

The extent of Fannie Mae's and Freddie Mac's losses will become clearer when the companies announce quarterly earnings next month. The government has agreed to backstop the companies if they falter.

Freddie Mac has not yet made a determination on its $18.4 billion in deferred tax assets, but it already had a slimmer financial cushion, and removing the tax assets would put it on shakier ground.

"The analysis of deferred tax assets at Freddie Mac is ongoing," said Corinne Russell, a spokeswoman for the Federal Housing Finance Agency, the companies' regulator.

Russell said Fannie Mae's decision on deferred tax assets was reviewed by the company's outside auditor.

The companies have lost nearly $15 billion over the past year.

Fannie Mae had $47 billion in capital at the end of the second quarter, on June 30. Freddie Mac had $37.1 billion in capital. Reducing those totals is unlikely to change how the companies do business, because of the government's backing.

The FHFA has suspended capital requirements for the companies, but the figure still gives a helpful measurement of their financial conditions.

To determine whether to pump money into the companies, the government relies on a measure known as shareholders' equity. If shareholders' equity is negative, the government will put money into the companies.

Fannie's shareholder equity was $41.2 billion at the end of June. Freddie Mac's was $12.9 billion.

Without counting deferred tax assets, Fannie Mae's shareholder equity would shrink to $21 billion. Freddie's would be negative $6 billion, prompting a government investment.

In the months leading up to the companies' takeover, the firms and their federal regulator cited the capital positions in an effort to allay fears about their financial security. But during a summer probe of the companies' books, government officials grew concerned about whether the financial cushions were sufficient. In particular, the deferred tax assets drew scrutiny.

Government-appointed Fannie Mae chief executive Herbert M. Allison Jr. and Freddie Mac chief executive David M. Moffett are reviewing a range of accounting policies at the company. At Fannie Mae, Allison decided the company had to be more forthright in how it reports information about the liquidity of certain assets.

Some analysts say the decision on tax assets is just the start of a reassessment of the companies' true financial position. Some have questioned whether the companies have accurately put a value on other assets.

"For now, Fannie and Freddie are wards of the state and the decision to address net deferred tax assets is part of the long-delayed reckoning with the downside impact of 65-to-1 leverage," Washington research firm Federal Financial Analytics said in a statement yesterday.

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