The regulator that oversees mortgage concerns Fannie Mae and Freddie Mac said this week that the condition of both enterprises "warrants significant supervisory concern."

The summation came in the Office of Federal Housing Enterprise Oversight's annual report to Congress released this week. The report offered a detailed overview of the troubles and remediation efforts at both entities, which are each revamping their internal controls and accounting systems following separate revelations of major accounting issues.

"Fannie Mae and Freddie Mac each were profitable in 2004 but faced internal and external challenges. Internally, both enterprises had to address serious accounting and control problems. Externally, a major shift in the composition of primary mortgage market loan production and increased demand for mortgages by other investors diminished investment opportunities for Fannie Mae and Freddie Mac," the OFHEO report said.

"Overall, Fannie Mae's condition warrants significant supervisory concern," the OFHEO report said. "The quality of policies, controls and communication varied among the business lines due to weaknesses in the program of former executive management. The program failed to establish an explicit baseline of standards that ensured all enterprise activities consistently met industry standards in policies, controls and communication. These weaknesses, coupled with a focus on expense control, impeded or prevented Fannie Mae from building aspects of the organizational structure and culture needed to effectively manage the company through significant business growth."

The OFHEO said that Fannie Mae's reporting to the board needs improvement; that a lack of a centralized authority in operations and weaknesses in independent risk oversight prevented several deficiencies from being detected, reported and corrected; that its organizational structure failed to provide fundamental controls for the controller department; and that deficiencies identified inadvertently or through reviews conducted by Fannie Mae and the OFHEO indicate that several areas in operations controls need strengthening.

"Overall, the condition of the enterprise is improving but continues to warrant supervisory concern," the OFHEO said of Freddie Mac. "During 2004 the board of directors and senior management made concerted efforts to correct extensive control weaknesses of the enterprise. OFHEO examiners observed improvements in both financial reporting and general operational controls. Although the remediation of internal control weaknesses is not complete, action plans are in place, or are being developed and implemented, to address identified weaknesses."

Separately, the House Appropriations Subcommittee on Wednesday approved the full funding request submitted by the OFHEO, giving it $60 million in federal money in fiscal 2006.

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