OIG says there is a significant financial magnitude to thernGSEs’ risk management programs and quality control processes brought about byrnthese changes, especially the change in responsibility for loan underwriting.   In 2013, the first year for the newrnframework, the GSEs bought approximately 5.6 million loans from sellers with arntotal unpaid principal balance exceeding $1.13 trillion.  This elevated risk was the reason the FHFArnOIG audited FHFA’s oversight of the GSEs’ implementation of the new framework.</p

OIG’s criticism of FHFA’s oversight of the framework changesrnrevolves primarily around the process under which the new framework was designedrnand implemented.  The Office provides thernfollowing background of that process.  </p

During the design andrndiscussion period leading up to the changes each of the GSEs reviewed the risksrninvolved in the changes.  FreddiernMac did a complete risk analysis finding that while the additional pre- andrnpost-funding assessments could result in better initial quality controlrnsampling and loan reviews, after the repurchase requirement sunsets and creditrnrisk transfers to the company those risks would increase.  Accurate identification of loan sunset eligibility,rnthe representation and warranty holder at any given time, and the sunset daternwould be critical to monitoring risk and accurately enforcing qualityrncontrol.  </p

Freddie Mac also identified where additional resources wouldrnbe needed in the form of increased staff, updated processes and procedures, andrnnew or enhanced technology and systems. It specifically identified two systems it would need to create inrnaddition to enhancing multiple existing systems and estimated it would take twornyears for full functionality of the systems. rn</p

Fannie Mae did not prepare a similar risk analysis but it didrncomplete a pre-implementation review of the new framework and issued itsrnfindings one day after the new framework became effective.  It identified fifteen individual work streamsrnrelated to FHFAs directive and communicating the new approach to sellers,rndeveloping new analytical tools, refining existing defect definitions and actionsrnfor findings, and developing new analytical tools to identifyrnand select a statistically valid sample population.   As of July 2014 Fannie Mae was still in thernprocess of completing implementation of new and enhanced systems to support thernframework with full roll-out projected for late 2015.  </p

FanniernMae’s internal review notably found nornformally documented, integrated vision within the company for how the redesigned processes and systems willrnoperate in the future, or how other stakeholders may be affectedrnby the change.  Itrnconcluded thatrnthe full scope of efforts needed to implement change and manage the associatedrnrisks would not be known until managementrncould articulate such arnvision and that company-wide impacts and risks would not be mitigatedrnuntil after the Januaryrn1, 2013, effective date for the new framework.</p

FHFA reviewed the proposals, studies,rnand risk analysesrnprovided by the GSEs and movedrnforward with its plans to announce a new framework in September 2012. The sunset period set by FHFA was 36rnmonths of consecutive on-time payments or 60 monthsrnif the loan was current on the 60th month,rnprovided there were no more than two 30-day delinquencies in the firstrn36 months.   OIG noted that FHFA set this sunset period withoutrnanalyzing whether financial risks were appropriately balanced between the GSEsrnand the sellers nor did it validate the GSEs’ analyses on the subject.  Fannie Mae’s supported the suggested 36rnmonths as sufficient to sunset repurchase obligations but Freddie Mac suggestedrnthat loans with 48 months of clean payments were significantly less likely tornexhibit repurchaseable defects.  OIG saysrnthis indicates a longer sunset period could lesson losses and that the FHFArncannot support that its decision does not unduly benefit sellers over the GSEs.</p

FHFA’s Office of Housing and Regulatory Policy (OHRP) explained that FHFA’s Acting Director and senior executives were briefed in June 2012 and adoptedrnthe 36 month sunset period.  Other keyrndecisions about the “term sheet” required the use of automatedrnunderwriting systems or risk assessment, specified appraisal requirements,rncollateral valuation checks, enhanced performing loan sampling and otherrnquality control measures.  </p

The final term sheet wasrnadopted September 6, 2012 andrnincluded the addition of three loan level eligibility criteria, including a sunset periodrnof 12 months for one FreddiernMac and two Fannie Mae refinancernproducts.  Four days later FHFArndirected the GSEs tornreplace the existingrnframework with the amendedrnframework and commence implementation. </p

More thanrna year later, on May 12, 2014, the GSEs announced a number of significant FHGA directed enhancements to the frameworkrnfor loans deliveredrnto them after July 1, 2014. These included:</p<ul class="unIndentedList"<liRelaxing the acceptable payment historyrnfor mortgages (with the exception of certain refinance mortgages) from the previous 60 monthly paymentsrnto 36 monthly payments.</li</ul<ul class="unIndentedList"<liAdding a pathrnfor relief the satisfactory conclusion of a GSE quality controlrnreview of the mortgage.</li</ul<ul class="unIndentedList"<liProviding sellersrnwith written notices of mortgagesrnthat met the eligibility requirements for reliefrnfrom the sellingrnrepresentations and warranties.</li</ul<ul class="unIndentedList"<liImplementing anrnalternative wherein the seller might "standrnin" on a mortgage rather than being required to repurchase should the primary mortgagerninsurance be rescinded. </li</ul

Coinciding with these changes FHFArnreleased its 2014 Strategic Plan for the Conservatorships of Fannie Mae andrnFreddie Mac. FHFA’s strategic plan indicated that in an effort to providerngreater market certainty, FHFA would evaluate and act, where appropriate, onrnchanges to the framework. Further, the strategicrnplan stated that lack of clarityrnabout representation and warrantyrnrequirements can contribute to decisions by sellersrnto add credit overlays that can unnecessarily limit accessrnto credit and that greater certaintyrnabout both origination and servicing obligations should help increase sellers’rnwillingness tornmore fully providerncredit within the GSEs’ underwritingrnstandards.rn</p

FHFA is planning futurernchanges 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-monthrnsunset period.   During the next year, FHFA will also explore:</p<ul class="unIndentedList"<liEstablishing an independent dispute resolution program when lendersrnbelieve a repurchase is unwarranted;</li</ul<ul class="unIndentedList"<liDeveloping cure mechanisms for loan defects rather than relyingrnsolely on repurchases; and</li</ul<ul class="unIndentedList"<liProviding additional clarity on Fannie Mae and FreddiernMac underwriting rules.</li</ul

OIG also found that despiternsignificant changes to the GSEs’ systems andrnprocesses, 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 effortsrnfrom nonperforming loans where underwriting defects may be more obviousrnto the larger population of performing loans within the sunset period.rn</p

Asidernfrom a product specific one FHFA does not intend to conduct furtherrnreviews on new framework qualityrncontrol processesrnunder its 2014 examination plan, but will considerrnincorporating this activity into the 2015 plan.  Also FHFA has not examined any of the systemsrnthat Freddie Mac identified in its risk analysis that it needed to establishrnor enhance to supportrnthe new framework norrnscheduled exams for Fannie Mae of its needed quality control processes andrnsystems.   </p

In summary, OIG found that FHFA mandated a 36-month sunset Period for representation and warranty Relief withoutrnvalidating the GSEs’ analyses or performing sufficientrnanalysis to appropriately balance financialrnrisk between the GSEs and Sellers</p

Based on this finding OIG recommends that FHFA:rn</p

1.   Assessrnthe current state ofrnthe GSE’s critical risk assessment tools, representations and warranties trackingrnsystems, and other systems, to determine whether they are appropriate to minimize financialrnrisk from the new framework. The resultsrnshould document any areas of identified risk, planned actions,rnand corresponding timelines to mitigaterneach area identified and provide an estimate of when each GSErnwill be reasonably equipped to work safely and soundly within the newrnframework.</p

2.   Perform a comprehensive analysis to assess whetherrnfinancial risks associated with the new representation and warrantyrnframework are appropriately balanced betweenrnthe GSEs and sellers. Thisrnanalysis should be based on consistent transactional data across the GSEs and identifyrnpotential costs and benefits to them and document consideration of the FHFA’srnobjectives.</p

FHFA partially agreed with the firstrnrecommendation and will request that the GSEs provide information about neededrnoperational changes to accomplish this and will take this information intornaccount in developing its examination plans for 2015.</p

As to the second recommendation, FHFA disagreesrnand says it will not perform an analysis of the financial risks associated withrnthe new framework.  It claims thatrnrevisiting decisions about the sunset periods and the related payment historyrnrequirements may have adverse market impact on future framework revisions andrnmay not align with its objective of increasing lending to consumers consistent with GSE safety and soundness.

All Content Copyright © 2003 – 2009 Brown House Media, Inc. All Rights Reserved.nReproduction in any form without permission of MortgageNewsDaily.com is prohibited.