Office of Chief Accountant issues Statement on Fannie Mae Accounting

[The Straight Story]

OFFICE OF THE CHIEF ACCOUNTANT ISSUES STATEMENT ON FANNIE MAE ACCOUNTING

Our review indicates that during the period under our review, from
2001 to mid-2004, Fannie Mae’s accounting practices did not comply
in material respects with the accounting requirements in Statement
Nos. 91 and 133.

Donald T. Nicolaisen, Chief Accountant for the Securities and Exchange
Commission (Commission), issued the following statement regarding the
compliance of the Federal National Mortgage Association’s (Fannie Mae)
accounting practices for deferred purchase price adjustments and for
derivatives and hedging activities with Statement of Financial
Accounting Standards No. 91, “Accounting for Nonrefundable Fees and
Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases” (Statement No. 91), and Statement of Financial
Accounting Standards No. 133, “Accounting for Derivative Instruments and
Hedging Activities” (Statement No. 133):

At the request of Fannie Mae, the accounting staff at the
Commission has been reviewing whether the accounting used by Fannie
Mae complied with Statement Nos. 91 and 133.

The Office of Federal Housing Enterprise Oversight (OFHEO), Fannie
Mae’s safety and soundness regulator, has reviewed several of
Fannie Mae’s accounting practices, focusing on the implications of
those practices on the adequacy of Fannie Mae’s regulatory capital,
the quality of its management, and the overall safety and soundness
of the enterprise. OFHEO issued a preliminary report of its
findings on September 17, 2004.

Following the issuance of OFHEO’s report, Fannie Mae sought
guidance from the Commission’s accounting staff regarding
accounting policy matters associated with Fannie Mae’s compliance
with Statement Nos. 91 and 133. Although it is unusual for the
accounting staff to provide such guidance while there are pending
investigations by the Commission and other agencies, Fannie Mae
requested our guidance because, in its view, these accounting
issues have received extraordinary public attention and resulted in
the mortgage and capital markets experiencing uncertainty. Fannie
Mae did not ask the accounting staff to express any views on
factual matters or matters that require factual development and, in
providing the requested guidance, we are not expressing any such
views. The staff’s guidance is based solely on information
voluntarily provided by Fannie Mae and OFHEO.

In light of the public attention and uncertainties cited by Fannie
Mae in its request, and other matters involving Fannie Mae that are
publicly available, including OFHEO’s report, we are issuing this
statement of the staff’s views. The issues considered by the SEC
staff were not the appropriateness of Fannie Mae’s business
decisions to use financial or derivative instruments or to hedge
its risks, but whether the accounting used to record those
transactions complied with Statement Nos. 91 and 133.

Our review indicates that during the period under our review, from
2001 to mid-2004, Fannie Mae’s accounting practices did not comply
in material respects with the accounting requirements in Statement
Nos. 91 and 133.

Regarding Statement No. 91, during the period under the SEC staff’s
review, Fannie Mae failed to record timely adjustments to the
recorded amount of its loans based on changes in the estimated
speed with which those loans would be prepaid. Among other
requirements, Statement No. 91 provides that when applying the
method used by Fannie Mae an entity should use its best estimate of
expected prepayment rates in calculating the carrying amount of its
loans. Fannie Mae previously had concluded that its methodology
for performing these calculations for interim balance sheet dates
in the periods 2001 through 2002 was not consistent with Statement
No. 91, and has stated that it has changed its accounting policies
to, among other things, calculate the amounts based on quarter-end
positions rather than projected year-end positions.

It also appears that, contrary to Statement No. 91, Fannie Mae
recognized adjustments to the carrying amount of its loans only if
they exceeded a self-defined materiality limit, referred to as a
“precision threshold.” Fannie Mae has represented to the
Commission staff that it has initiated further changes to eliminate
the “precision threshold” and is working with OFHEO to further
amend its accounting practices under Statement No. 91.

Regarding Statement No. 133, one of the principles underlying the
statement is that derivative instruments are to be recorded at
their fair value with changes in fair value reported in earnings.
If certain hedge criteria are met, however, Statement No. 133
affords special accounting for the hedge relationship. If the
specific hedging requirements are not met, then special hedge
accounting is not appropriate.

Fannie Mae internally developed its own unique methodology to
assess whether hedge accounting was appropriate. Fannie Mae’s
methodology, however, did not qualify for hedge accounting because
of deficiencies in its application of Statement No. 133. Among
other things, Fannie Mae’s methodology of assessing, measuring, and
documenting hedge ineffectiveness was inadequate and was not
supported by the Statement.

We understand that Fannie Mae is working with an outside adviser to
amend its hedge accounting practices and develop an appropriate
approach to hedge accounting under Statement No. 133.

This evening, therefore, I have advised Fannie Mae that, to be
consistent with Statement Nos. 91 and 133 and to provide investors
with appropriate information, Fannie Mae should:

· Restate its financial statements filed with the Commission to eliminate
the use of hedge accounting.
· Evaluate the accounting under Statement No. 91 and restate its financial
statements filed with the Commission if the amounts required for correction
are material.
· Re-evaluate the information prepared under generally accepted accounting
principles (GAAP) and non-GAAP information that Fannie Mae previously
provided to investors, particularly in view of the decision that hedge
accounting is not appropriate.

I appreciate the cooperation extended by Fannie Mae and OFHEO
during our review and their willingness to provide us with
information and detailed explanations of their views. It is my
understanding that investigations into these and related matters by
Fannie Mae’s special review committee, the Commission, and others
are continuing. (Press Rel. 2004-172)


http://www.sec.gov/news/digest/dig121604.txt

[tjdee]

1. Ooohh, someone's in troubleeeeeee.....or no. Martha Stewart's in jail.

We don't actually have to go after people who do stuff like this. Martha Stewart is in prison, we can all sleep soundly now.

[happynewyear]

2. step right up

next = Freddie Mae, Fannie's evil twin!

:kick: