Federal Housing Finance Agency’s (FHFA) Office of the Inspector General (OIG)
has released an audit critical of the FHFA for decision making leading to
changes in the Representation and Warranty Framework for Fannie Mae and Freddie
Mac, the government sponsored enterprises (GSEs) under FHFA conservatorship. Those changes were a component of FHFA’s
Contract Harmonization Project initiated in June 2011 to improve the GSEs’
contracts and contracting processes with its seller servicers.
As a result of discussions between
FHFA and the GSEs the Agency determined that contract harmonization was
necessary and appropriate and on January 19, 2012 directed the GSEs to align their
contracts in eight areas, two of which were priorities with 180 day deadlines:
1) Consistent and precise benchmarks and measurable standards for repurchase
requests and other penalties for non-performance and 2) Consistent timelines
and collection standards for fees and penalties. The first priority initiated the process of
changing the GSEs’ representation and warranty framework which was implemented
on January 1, 2013.
Under the pre-2013 contracts seller
representations and warranties generally related to the underwriting of the
borrower, the mortgaged premises, and the project within which the property is
located. Where a mortgage was not
compliant with Fannie Mae’s Selling Guide
or Freddie Mac’s purchase documents the GSEs could exercise contractual
remedies including a request for repurchase. The changes made to the framework
were designed to
clarify seller repurchase exposure and liability on loans sold to the GSEs with
the goal of maximizing the seller-servicers performance and therefore the
economic return of the GSEs’ loan portfolio.
highlights of the new framework were:
Relieving sellers of certain
repurchase obligations for loans that met specific payment requirements
such as 36 months of consecutive, on-time payments.
Making Home Affordable Refinance
Program (HARP) loans eligible for representation and warranty
relief after an acceptable payment history of only 12 months.
Detailing information about exclusions for representation and warranty
relief, such as violations of state, federal,
and local laws and regulations.
range of tolls available to sellers to help improve loan quality.
The new framework
also moved the focus of quality control reviews from the time a loan defaults
up to the time the loan is delivered
to Fannie Mae and Freddie Mac. FHFA also directed the GSEs to:
control reviews earlier
in the loan process,
generally between 30 to 120 days
after loan purchase.
- Establish consistent timelines for sellers to submit
requested loan files for review.
Evaluate loan files on a more comprehensive basis to ensure a focus
on identifying significant deficiencies.
Leverage data from the tools currently used by Fannie Mae and Freddie
Mac to enable earlier
identification of potentially defective loans.
Make available more transparent appeals processes
for sellers to appeal repurchase requests.
OIG says there is a significant financial magnitude to the
GSEs’ risk management programs and quality control processes brought about by
these changes, especially the change in responsibility for loan underwriting. In 2013, the first year for the new
framework, the GSEs bought approximately 5.6 million loans from sellers with a
total unpaid principal balance exceeding $1.13 trillion. This elevated risk was the reason the FHFA
OIG audited FHFA’s oversight of the GSEs’ implementation of the new framework.
OIG’s criticism of FHFA’s oversight of the framework changes
revolves primarily around the process under which the new framework was designed
and implemented. The Office provides the
following background of that process.
During the design and
discussion period leading up to the changes each of the GSEs reviewed the risks
involved in the changes. Freddie
Mac did a complete risk analysis finding that while the additional pre- and
post-funding assessments could result in better initial quality control
sampling and loan reviews, after the repurchase requirement sunsets and credit
risk transfers to the company those risks would increase. Accurate identification of loan sunset eligibility,
the representation and warranty holder at any given time, and the sunset date
would be critical to monitoring risk and accurately enforcing quality
Freddie Mac also identified where additional resources would
be needed in the form of increased staff, updated processes and procedures, and
new or enhanced technology and systems. It specifically identified two systems it would need to create in
addition to enhancing multiple existing systems and estimated it would take two
years for full functionality of the systems.
Fannie Mae did not prepare a similar risk analysis but it did
complete a pre-implementation review of the new framework and issued its
findings one day after the new framework became effective. It identified fifteen individual work streams
related to FHFAs directive and communicating the new approach to sellers,
developing new analytical tools, refining existing defect definitions and actions
for findings, and developing new analytical tools to identify
and select a statistically valid sample population. As of July 2014 Fannie Mae was still in the
process of completing implementation of new and enhanced systems to support the
framework with full roll-out projected for late 2015.
Mae’s internal review notably found no
formally documented, integrated vision within the company for how the redesigned processes and systems will
operate in the future, or how other stakeholders may be affected
by the change. It
the full scope of efforts needed to implement change and manage the associated
risks would not be known until management
could articulate such a
vision and that company-wide impacts and risks would not be mitigated
until after the January
1, 2013, effective date for the new framework.
FHFA reviewed the proposals, studies,
and risk analyses
provided by the GSEs and moved
forward with its plans to announce a new framework in September 2012. The sunset period set by FHFA was 36
months of consecutive on-time payments or 60 months
if the loan was current on the 60th month,
provided there were no more than two 30-day delinquencies in the first
36 months. OIG noted that FHFA set this sunset period without
analyzing whether financial risks were appropriately balanced between the GSEs
and the sellers nor did it validate the GSEs’ analyses on the subject. Fannie Mae’s supported the suggested 36
months as sufficient to sunset repurchase obligations but Freddie Mac suggested
that loans with 48 months of clean payments were significantly less likely to
exhibit repurchaseable defects. OIG says
this indicates a longer sunset period could lesson losses and that the FHFA
cannot support that its decision does not unduly benefit sellers over the GSEs.
FHFA’s Office of Housing and Regulatory Policy (OHRP) explained that FHFA’s Acting Director and senior executives were briefed in June 2012 and adopted
the 36 month sunset period. Other key
decisions about the “term sheet” required the use of automated
underwriting systems or risk assessment, specified appraisal requirements,
collateral valuation checks, enhanced performing loan sampling and other
quality control measures.
The final term sheet was
adopted September 6, 2012 and
included the addition of three loan level eligibility criteria, including a sunset period
of 12 months for one Freddie
Mac and two Fannie Mae refinance
products. Four days later FHFA
directed the GSEs to
replace the existing
framework with the amended
framework and commence implementation.
a year later, on May 12, 2014, the GSEs announced a number of significant FHGA directed enhancements to the framework
for loans delivered
to them after July 1, 2014. These included:
Relaxing the acceptable payment history
for mortgages (with the exception of certain refinance mortgages) from the previous 60 monthly payments
to 36 monthly payments.
Adding a path
for relief the satisfactory conclusion of a GSE quality control
review of the mortgage.
with written notices of mortgages
that met the eligibility requirements for relief
from the selling
representations and warranties.
alternative wherein the seller might “stand
in” on a mortgage rather than being required to repurchase should the primary mortgage
insurance be rescinded.
Coinciding with these changes FHFA
released its 2014 Strategic Plan for the Conservatorships of Fannie Mae and
Freddie Mac. FHFA’s strategic plan indicated that in an effort to provide
greater market certainty, FHFA would evaluate and act, where appropriate, on
changes to the framework. Further, the strategic
plan stated that lack of clarity
about representation and warranty
requirements can contribute to decisions by sellers
to add credit overlays that can unnecessarily limit access
to credit and that greater certainty
about both origination and servicing obligations should help increase sellers’
more fully provide
credit within the GSEs’ underwriting
FHFA is planning future
changes to the new framework and is addressing the scope of life of loan exemptions, recognizing lenders’ concerns about how these exemptions apply to loans that have passed quality control reviews or have met the 36-month
sunset period. During the next year, FHFA will also explore:
Establishing an independent dispute resolution program when lenders
believe a repurchase is unwarranted;
Developing cure mechanisms for loan defects rather than relying
solely on repurchases; and
Providing additional clarity on Fannie Mae and Freddie
Mac underwriting rules.
OIG also found that despite
significant changes to the GSEs’ systems and
processes, FHFA has done little to ensure that necessary controls are in place and operating effectively prior to sunset. The GSEs need to shift primary quality control efforts
from nonperforming loans where underwriting defects may be more obvious
to the larger population of performing loans within the sunset period.
from a product specific one FHFA does not intend to conduct further
reviews on new framework quality
under its 2014 examination plan, but will consider
incorporating this activity into the 2015 plan. Also FHFA has not examined any of the systems
that Freddie Mac identified in its risk analysis that it needed to establish
or enhance to support
the new framework nor
scheduled exams for Fannie Mae of its needed quality control processes and
In summary, OIG found that FHFA mandated a 36-month sunset Period for representation and warranty Relief without
validating the GSEs’ analyses or performing sufficient
analysis to appropriately balance financial
risk between the GSEs and Sellers
Based on this finding OIG recommends that FHFA:
the current state of
the GSE’s critical risk assessment tools, representations and warranties tracking
systems, and other systems, to determine whether they are appropriate to minimize financial
risk from the new framework. The results
should document any areas of identified risk, planned actions,
and corresponding timelines to mitigate
each area identified and provide an estimate of when each GSE
will be reasonably equipped to work safely and soundly within the new
2. Perform a comprehensive analysis to assess whether
financial risks associated with the new representation and warranty
framework are appropriately balanced between
the GSEs and sellers. This
analysis should be based on consistent transactional data across the GSEs and identify
potential costs and benefits to them and document consideration of the FHFA’s
FHFA partially agreed with the first
recommendation and will request that the GSEs provide information about needed
operational changes to accomplish this and will take this information into
account in developing its examination plans for 2015.
As to the second recommendation, FHFA disagrees
and says it will not perform an analysis of the financial risks associated with
the new framework. It claims that
revisiting decisions about the sunset periods and the related payment history
requirements may have adverse market impact on future framework revisions and
may not align with its objective of increasing lending to consumers consistent with GSE safety and soundness.