Giants Masking Billions in Losses for Overdue Mortgages

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A Freddie Mac signs stands on the grounds of the company's headquarters in McLean, Virginia, U.S., on Thursday, Dec. 30, 2010. Mortgage rates for U.S. loans climbed to a seven-month high, increasing borrowing costs for homebuyers in a sluggish real estate market. Photographer: Andrew Harrer/Bloomberg via Getty Images
Andrew Harrer/Bloomberg via Getty Images
WASHINGTON -- 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.
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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 Jan. 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 Aug. 2, that Fannie and Freddie haven't 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 Aug. 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."

22 PHOTOS
Companies Paying The Most and Least Taxes
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Giants Masking Billions in Losses for Overdue Mortgages

10. Microsoft
Income tax expense: $4.57 billion
Earnings before taxes: $20.03 billion
Revenue: $72.93 billion
1-yr. share price change: -12.04%
Industry: Software

In an industry in which success is often measured against fast-growing Google (GOOG) and Apple (AAPL), Microsoft has been maligned for its lack of innovation and the resulting poor growth. What is ignored in that analysis is that Microsoft remains a money machine and has huge operating margins in two of its oldest divisions. Microsoft had a net income of $6.38 billion in its fiscal second quarter on revenue of $21.5 billion. The Windows division alone had an operating income of $3.3 billion on revenue of $5.9 billion, a 56% margin. The business division had an operating income of $3.6 billion on $5.7 billion in revenue, a 63% margin. Other divisions, however, dragged down results. Microsoft's online operations, including its Bing search engine and its entertainment division, which markets Xbox products, posted operating losses. Largely due to the success of the two older operations, Microsoft has paid more than $5 billion in taxes in four of the past five years.

9. IBM
Income tax expense: $5.30 billion
Earnings before taxes: $21.90 billion
Revenue: $104.51 billion
1-yr. share price change: 7.57%
Industry: IT consulting

International Business Machines (IBM), by most measures, is the second largest technology company in the United States, just behind Hewlett-Packard (HPQ). However, there are significant differences between the two. Most notably, HP is falling apart, while IBM's continued success, most recently under its first female CEO, Ginni Rometty, has landed it on this list. One critical reason for IBM's health is that it operates in a broad array of businesses, which means it doesn't need to rely on a single sector of the tech world. While IBM may be most associated with hardware and its long line of mainframes, its software operations and IT services division are just as large. IBM is also geographically diversified, and large fractions of its sales come from Europe and Asia.

8. Berkshire Hathaway
Income tax expense: $6.92 billion
Earnings before taxes: $22.24 billion
Revenue: $162.46 billion
1-yr. share price change: 31.01%
Industry: Asset management

The house that Warren Buffett built continues to grow. Buffett bought huge railroad company Burlington Northern Santa Fe in 2009 for $34 billion. More recently, he agreed to buy Heinz in partnership with investment company 3G Capital. The sticker price on that transaction is $23 billion. Berkshire Hathaway (BRK-A) also holds large positions in American Express (AXP), Coca-Cola Co. (KO), ConocoPhillips (COP) and General Electric (GE). And its derivatives trading operations booked a $1.4 billion gain in the fourth quarter.

7. J.P. Morgan
Income tax expense: $7.63 billion
Earnings before taxes: $28.92 billion
Revenue: $91.66 billion
1-yr. share price change: 24.30%
Industry: Financial services

Almost all the recent news coverage of J.P. Morgan Chase & Co. (JPM) has been negative. What was once considered the best-run bank in the United States has gone through a series of missteps, the most visible of which was a $6 billion trading loss due to the actions of a rogue trader in its London offices. The loss cost several senior J.P. Morgan executives their jobs and tarnished the reputation of CEO Jamie Dimon. And last week, a Senate panel accused the bank of a cover-up of the London Whale debacle. Despite all that, J.P. Morgan's earnings have been solid and rose 53% in the fourth quarter, largely due to strong results in its mortgage operations.

6. ConocoPhillips
Income tax expense: $7.94 billion
Earnings before taxes: $15.42 billion
Revenue: $60.35 billion
1-yr. share price change: -22.86%
Industry: Energy exploration and production

ConocoPhillips joins its larger rivals Exxon and Chevron Corp. (CVX) on the top taxpayer list. By sales, ConocoPhillips was the fourth largest public corporation in the U.S. until it recently broke itself into two pieces. One of the new companies, Phillips 66 (PSX), holds the former parent's downstream assets -- those that handle refining and marketing. The rest of ConocoPhillips, which kept the parent's name, is the largest of all the U.S.-headquartered energy exploration and production companies. Among the company's initiatives are plans to drill above the Arctic Circle beginning in 2014. The move is risky. Royal Dutch Shell (RDS-A) recently stopped its operations in the same area due to engineering problems. ConocoPhillips also has significant assets in the Far East and runs the deep-water drilling operations in China's largest offshore oil field.

5. Walmart
Income tax expense: $7.98 billion
Earnings before taxes: $25.74 billion
Revenue: $469.16 billion
1-yr. share price change: 21.87%
Industry: Supermarkets

Walmart Stores (WMT) is the largest company in the United States and the largest employer. Unlike some of the other companies on the highest taxpayer list, particularly the banks and oil companies, Walmart is relatively young, founded in 1962, but its expansion at the expense of traditional American retailers like Sears, Kmart and J.C. Penney (JCP) has made it remarkably profitable. Walmart's annual tax payment has been above $7 billion in each of its past five fiscal years. At this point, Walmart's size has become something of a disadvantage because it has become hard for the retailer to grow much faster than the economy in general. Recently, the company's U.S. same-store sales were up only 2.2%. Noted Charles M. Holley Jr., Walmart's chief financial officer: "I don't think the economy's helping us."

4. Wells Fargo
Income tax expense: $9.10 billion
Earnings before taxes: $28.47 billion
Revenue: $79.45 billion
1-yr. share price change: 16.77%
Industry: Banks

Wells Fargo & Co. (WFC) is often considered the most successful of the four U.S. money center banks, the others being Citigroup (C), J.P. Morgan Chase and Bank of America (BAC). Since the start of 2008 (when it bought Wachovia and nearly doubled in size), the year of the global financial crisis, Wells Fargo shares have rallied more than those of the other three. Wells Fargo's success is largely due to the fact that it has not relied heavily on investment banking and proprietary trading. The former is considered an unreliable source of revenue, the latter risky. Wells Fargo leans more on consumer banking. And its national customer base tends to be concentrated in a few markets that it dominates. That keeps the firm's cost of maintaining large numbers of branches low. As Morningstar recently commented, "more than one third of the bank's deposits come from markets in which Wells Fargo is the preeminent player, and more than two thirds are gathered in markets in which the company ranks among the top three." Wells Fargo's annual tax bill dropped as low as $602 million in 2008, but has risen steadily each year since.

3. Apple
Income tax expense: $14.21 billion
Earnings before taxes: $55.96 billion
Revenue: $164.69 billion
1-yr. share price change: -20.68%
Industry: Computer hardware

Apple rapid ascent to the apex of the tech world has been mirrored by its leap up the ladder of top corporate taxpayers. Thanks to strong sales of iPads, iPhones and Mac products (not to mention its iTunes and App Store revenues), its tax payments rose from $2 billion four years ago to $4.5 billion two years ago, and tripled since then. But these days, Apple is facing several growth challenges, which already have cut its stock price by one-quarter from record levels. Samsung passed Apple in smartphone sales in 2011, and the iPad's dominance is under threat from Google Android-based tablets, which are on track to surpass Apple iOS-based products this year, according to research firm IDC. Other threats to Apple's growth include the fact that its successes in China have been very modest.

2. Chevron
Income tax expense: $20.00 billion
Earnings before taxes: $46.33 billion
Revenue: $222.58 billion
1-yr. share price change: 9.52%
Industry: Oil and gas

Chevron is the third largest public company in the U.S. based on sales, just above another energy multinational, ConocoPhillips, which was recently broken into two parts. Chevron has paid more than $10 billion a year in taxes in every year except one since 2005. And its revenue since the same year has only once dropped below $200 billion during that time. Like other large energy companies, it has added liquid natural gas to its reserve base, because natural gas currently accounts for 23% of the world's energy consumption. One challenge Chevron faces as it moves forward is the difficulty of finding new oil fields. This will require Chevron to make greater and greater efforts at deep-water drilling and oil sands production. Chevron is sanguine about its long-term prospects; it expects to increase production 20 percent by 2017.

1. Exxon Mobil
Income tax expense: $31.05 billion
Earnings before taxes: $78.73 billion
Revenue: $428.38 billion
1-yr. share price change: 6.56%
Industry: Oil and gas

Large multinational oil companies have been among the largest payers of corporate federal taxes for years. Exxon's income tax amount was approximately the same in 2011 as it was in 2012 - $31 billion. A simple reason for Exxon's position at the top of the tax paying list is its size. It vies with Walmart each year for the spot as the publicly traded U.S. company with the greatest revenue. Exxon's revenue has averaged more than $400 billion a year from 2007 to 2012. Part of Exxon's success is tied to the price of crude oil. A barrel of WTI crude was worth $35 in 2003. The price reached $60 in 2006 and rarely dropped below it thereafter. It rose above $100 in 2008 and has occasionally topped that price since then. Whether Exxon can stay atop both the tax and revenue list much longer depends on several factors, not the least of which are new sources of energy led by solar, wind and particularly shale-based fossil fuels. One benefit Exxon has that may allow it to keep the top position as America's largest company is its role as the number one producer of natural gas.

10. Alpha Natural Resources
Income tax expense: -$550 million
Earnings before taxes: -$2.99 billion
Revenue: $6.98 billion
1-yr. share price change: -47.43%
Industry: Coal and fuels

Alpha Natural Resources (ANR), a metal and coal mining company, made the mistake of buying peer Massey Energy for $7.1 billion. One of Massey's mines collapsed in 2010 and killed 29 miners, the worst such incident in the country in 40 years. Alpha was left with the bill for a $210 million settlement. Prices for the kind of thermal coal that Alpha produces are also low, thanks in part to the natural gas boom. These factors caused Alpha to book an asset impairment charge of more than $1 billion and a goodwill write-down of $1.7 billion last year. The write-downs triggered a $2.8 billion operating loss for the year. As a result, Alpha got a large tax benefit of $550 million.

9. J.C. Penney
Income tax expense: -$551 million
Earnings before taxes: -$1.54 billion
Revenue: $12.99 billion
1-yr. share price change: -58.05%
Industry: Department stores

J.C. Penney Co. Inc. (JCP) took an odd path to its tax status. In an attempt to revive the stagnant retailer, new CEO Ron Johnson made radical changes to its merchandising approach -- and put the company into sales death-spiral instead. Same-store sales fell more than 20% last year. Revenue from Internet sales fell even more. The fourth quarter was particularly brutal. Revenue dropped 25% to $3.4 billion, and the company posted a net loss of $552 million. Turns out, former Apple retail chief Johnson may have been the wrong choice for J.C. Penney, which, unlike Apple, doesn't have products with almost limitless demand. One of J.C. Penney's largest shareholders, Vornado Realty, dumped a large number of shares recently as it pulled support for the imploding retailer. There are persistent rumors that Johnson will be dumped.

8. AMR
Income tax expense: -$569 million
Earnings before taxes: -$2.45 billion
Revenue: $24.86 billion
1-yr. share price change: N/A (Chapter 11)
Industry: Airlines

AMR Corp., parent of American Airlines, earned much of its tax credit by filing for Chapter 11. The company should emerge from bankruptcy soon, as it merges with US Airways Group (LCC). Most of AMR's losses, which reached $1.1 billion in the fourth quarter, came from the write-down of the value of its planes and property, and because of high jet fuel costs. AMR didn't participate in the consolidation wave that hit the airline industry during the recession, and missed out on benefits that often are supposed to to be part of airline marriage: fewer planes, fewer employees, and consolidated routes. AMR is getting its merger now, but it has come too late for shareholders.

7. Lear
Income tax expense: -$638 million
Earnings before taxes: $679 million
Revenue: $14.57 billion
1-yr. share price change: 22.88%
Industry: Auto parts and equipment

Lear Corp. (LEA), one of the largest suppliers of car parts, filed for Chapter 11 at the peak of the auto industry's crisis, in 2009. Like General Motors (GM) and Chrysler, it emerged from bankruptcy quickly. Lear's restructuring worked, and it has even worked well enough to cause activist investors to seek board seats to force the company to distribute more cash. But the company's success is relatively new. In 2010, Lear only made $461 million on $12 billion in revenue. Net income shot up last year to $1.3 billion, although some was due to a tax credits. Audit settlements helped drive the $638 million tax benefits as did valuation credits from operations in other countries

6. Verizon Communications
Income tax expense: -$660 million
Earnings before taxes: $9.90 billion
Revenue: $115.85 billion
1-yr. share price change: 23.96%
Industry: Telecommunication services

Verizon Communications (VZ) is one of the most successful companies in America and the 15th largest in terms of total revenue. Its cellular business, co-owned with Vodafone Group PLC (VOD), has continued to grow, and it is now the largest provider in the U.S. based on subscriber counts. But the company's ancient landline business has continued to shrink as fewer and fewer people own home phones. Verizon's huge fourth quarter loss last year, however, had nothing to do with either landline shrinkage or day-to-day operations. Instead, it was the result of pension liabilities and damages from Superstorm Sandy. Verizon is one of the few examples of an extremely successful company temporarily paying no taxes.

5. D.R. Horton
Income tax expense: -$673 million
Earnings before taxes: $322 million
Revenue: $4.72 billion
1-yr. share price change: 58.50%
Industry: Home building

D.R. Horton (DHI) operates in one of the sectors hardest hit by the recession: home building. The company lost $2.6 billion in 2008 and $545 million in 2009. Horton's situation has improved substantially since then. Last completed fiscal year, the company had net income of $956 million on revenue of $4.4 billion. Donald R. Horton, chairman of the board, said when the company released results, "Our fiscal 2012 financial results reflect continued improvement in the housing market and in our company's performance. Our fourth quarter pre-tax income of $99.2 million was our highest in 22 quarters and contributed to our fiscal 2012 pre-tax income of $242.9 million, the highest since fiscal 2006." Horton's tax situation was driven by "a reduction of the company's valuation allowance for its deferred tax asset." As such, the amount had no effect on the company's operating performance.

4. Ameren
Income tax expense: -$680 million
Earnings before taxes: -$1.65 billion
Revenue: $6.64 billion
1-yr. share price change: 7.14%
Industry: Utilities

Ameren Corp. (AEE), the utility holding company, took huge write-downs last year on its merchant generation group, which marketed much of the power the company produced. Ameren said it would exit the business soon because the revenue it could get from power production was too low compared to the high cost of fuel. Ameren was fortunate recently to find a ready buyer in energy firm Dynergy (DYN). Among other benefits to the company, the sale, according to Reuters, "removes $825 million in debt from Ameren's balance sheet and will create an estimated $180 million in tax benefit." In other respects, Ameren is a relatively successful company. In 2011, the year before it took the write-offs, the company had revenue of $7.5 billion and net income of $526 million. Revenue in 2012 was $5.9 billion. Without the $2.6 billion impairment cost associated with its merchant business, the company would have been profitable again.

3. Caesars Entertainment
Income tax expense: -$871 million
Earnings before taxes: -$2.25 billion
Revenue: $8.59 billion
1-yr. share price change: 44.72%
Industry: Casinos and gaming

Caesars Entertainment Corp. (CZR), the casino operator, is another example of a relatively successful company that decided to write off some of its mistakes as well as the damage caused to its Atlantic City operations by Hurricane Sandy. Caesars also exited its attempts to enter the Biloxi, Miss., market. As a result, Caesars "loss from continuing operations net of income taxes" was nearly $1.4 billion. Because Caesars is so highly leveraged with debt, it would have lost money anyway. Last year's interest expense was $2.1 billion, about the same as in 2011. Caesars is not growing, so it will have a challenge even with the write-downs it took in 2012. Last year's revenue did not grow significantly from the year before. Caesars continues to be challenged by several other gaming companies, including Wynn Resorts (WYNN) and MGM Resorts International (MGM). Also, Caesars operations in Missouri, Indiana and Illinois have already suffered drops in revenue.

2. Bank of America
Income tax expense: -$1.12 billion
Earnings before taxes: -$3.07 billion
Revenue: $75.17 billion
1-yr. share price change: 50.68%
Industry: Financial services

Bank of America Corp.'s (BAC) tax situation is unique on this list: The bank settled a number of lawsuits with the U.S. government, most of which had to do with litigation over past home loan practices. Its 2012 settlement with the federal government over home loan foreclosure practices cost it $2.5 billion. Its settlement with Fannie Mae over troubled loans the bank sold to customers cost it $2.7 billion. Bank of America claims that these settlements put most of its problems behind it. When the firm announced full year earnings, its Chief Financial Officer Bruce Thompson said, "We addressed significant legacy issues in 2012 and our strengths are coming through." The bank has also continued its restructuring in the wake of the 2008 financial crisis, during which it made the questionable decisions to buy broker Merrill Lynch and subprime mortgage firm Countrywide Financial.

1. General Motors
Income tax expense: -$34.83 billion
Earnings before taxes: -$28.70 billion
Revenue: $152.26 billion
1-yr. share price change: 9.91%
Industry: Automobile manufacturers

Unlike J.C. Penney, GM did not receive its tax benefit because of operating success. The company received an "automotive interest expense" tax credit from the government, which was related to impairment of assets and amortization. This and related write-offs mean GM may not have to pay federal taxes for several years. Absent the write-offs, GM has done relatively well recently. Revenue reached $152.3 billion last year, up from $135.3 billion in 2010. GM's greatest challenge going forward is the losses in its European operations, which are made up mostly of its Opel and Vauxhall businesses. These losses have hurt global net income, offsetting some of GM's success in the United States and China. GM has posted red ink in Europe for 13 straight years, and the car industry there is so troubled that there is no end in sight.

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