Originally Posted At TheStreet.com
By Lauren Tara LaCapra
February 3, 2010

NEW YORK (TheStreet) -- A look at what's lying off the books at Fannie Mae(FNM Quote) and Freddie Mac(FRE Quote) provides some clues as to why the mortgage-finance giants recently received a "blank check" from the Treasury Department for future capital needs, and why the Obama administration has delayed announcing restructuring plans.

On Jan. 1, financial firms were due to recognize all assets that were previously held off-balance sheet in special vehicles. Before the accounting rule change took effect, firms were not required to reserve capital against potential losses on those assets.

Here are some startling statistics from Fannie and Freddie's third-quarter reports, as the market awaits word of the timing of year-end results:

As of Sept. 30, Fannie Mae had $164 billion worth of nonperforming loans held off the books, vs. $33.5 billion in recognized NPAs. Freddie Mac had $74.3 billion off balance sheet, and $17.3 billion on the books. (Freddie's figures may be lower because it counts just 90 plus days past due, whereas Fannie counts 30 plus days past due.)

Fannie has $3.58 trillion worth of off-balance sheet assets, vs. just $890 billion in assets on the books. The firm estimated a $2.4 trillion maximum exposure to loss for off-balance sheet assets. Since it's a worst-case scenario, maximum exposure isn't considered a realistic representation of what firms would actually lose. Nonetheless, Fannie had reserved just $56.9 billion for those losses at Sept. 30.

Freddie Mac identified $1.5 trillion in potential off-balance sheet credit losses, and said it had reserved $28.6 billion against such guarantees.

Off-balance sheet assets had been a concern for the banking industry as well. Even though firms had roughly a year to prepare for the shift in accounting rules, the credit markets didn't allow for quick disposal of off-balance sheet assets, some of which were toxic assets held in structured vehicles.

This was especially true for Wells Fargo(WFC Quote), which had a huge amount of mortgage securities held off the books, and Bank of America(BAC Quote), whose souring credit-card portfolio has been held in off-balance sheet trusts. While Wells had the most exposure, there were also concerns about Citigroup's(C Quote) more than $1 trillion in off-balance sheet assets -- mysterious in nature, and mistrusted by investors -- as well as JPMorgan Chase(JPM Quote).

But in fourth-quarter reports, the impact of the change, referred to as FAS 166 and 167, was muted. Wells successfully whittled down much of its exposure, and added just $10 billion to risk-weighted assets. The change marginally benefited its capital ratios. Bank of America expects to add $14 billion in risk-weighted assets, and $100 billion in overall assets, which it accounted for already in reserves for loan losses.

It's unclear what the impact will be for Fannie Mae and Freddie Mac, although it's likely to be much more significant. The two firms essentially own the mortgage market and have acknowledged that the shift stands to have a significant impact on capital needs, income statements, credit quality metrics and shareholders' net worth, which is only in the black because of the Treasury's capital infusions.

The Treasury Department announced on Christmas Eve that Fannie and Freddie would receive unlimited capital support over the next few years. The Obama administration was expected to announce a long-awaited restructuring proposal for the two firms in its budget proposal this month. Fannie and Freddie have been overseen and managed by the federal government in a conservatorship status since September 2008, but still maintain publicly traded stock.

The budget proposal came and went on Monday with much ado about deficits, but no word on the fate of Fannie Mae and Freddie Mac.

"It is hugely disappointing," Sen. Bob Corker (R., Tenn.), said in a statement, later adding that ""throughout the debate on regulatory reform, the future of the mortgage markets in the United States has been off the table."

Corker has been a vocal critic of the government's handling of Fannie and Freddie -- or lack thereof -- and sent a request for information to the Treasury Department on Jan. 11. Rep. Barney Frank (D., Mass.), who chairs the House Financial Services Committee, said earlier this month that he and his colleagues would probably suggest abolishing its current status, but didn't give any suggestions for an alternate solution.

But as luck would have it, another group of regulators have stepped in to help Fannie and Freddie with their off-balance sheet dilemma. The Federal Reserve, Federal Deposit Insurance Corp. and two other banking regulators decided earlier this month that they would allow banking entities a grace period of two additional quarters to recognize assets off the books, and reserve capital against potential losses.

In the meantime, Fannie and Freddie are working diligently to figure out how to move and account for the huge swath of mortgage assets that once existed in the brume off their books.

"We have devoted significant effort to this project, which involves several divisions within our company, hundreds of employees and contractors and a tremendous amount of work across our company," Fannie said in its quarterly filling.

--Written by Lauren Tara LaCapra in New York.