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OIG Finds FHFA Deficient in Oversight of Fannie Mae Underwriting Guidelines and Variances
On Thursday the Federal Housing FinancernAgency (FHFA) Office of Inspector General (OIG) released the results of threernevaluations of FHFA’s oversight of the two government sponsored enterprisesrn(GSEs) Freddie Mac and Fannie Mae. FHFArnis the successor conservator of the GSEs which were placed into governmentrnconservatorship in August 2008. Thernother two evaluations, one of the oversight of the GSEs’ charitable giving andrnthe other of Fannie Mae’s participation in an industry convention, were reported earlier this morning.</p
This audit concerns the extent of FHFA’srnoversight of Fannie Mae’s single-family mortgage underwriting standards. Specifically, OIG reviewed FHFA’s writtenrnpolicies for oversight of these standards and oversight of Fannie Mae’srninternal controls over its implementation of the standards. OIG also plans to contract for additionalrnaudit coverage related to the effectiveness of quality controls used by thernGSEs to determine compliance with underwriting standards.</p
The GSEs buy mortgages from lenders andrneither keep them as investments, or package and sell them to other investors. During the first 10 months of 2011, FanniernMae purchased nearly 2.1 million loans valued at $427 billion. To be eligible for purchase, a mortgage mustrnsatisfy the GSEs’ underwriting standards or have their approval to vary fromrnthem. Fannie Mae’s underwritingrnstandards, which it refers to as eligibility requirements, derive from arncombination of Congressional charter-based and traditional risk-based criteria. Charter-based criteria would include originalrnprincipal balance limits and loan-to-value ratios while risk based criteriarnfocus on collateral, capacity, and creditworthiness.</p
Notwithstanding the housing boom andrnsubsequent housing collapse, Fannie Mae’s basic underwriting standards forrnpurchase-money loans secured by single-family, principal residences have notrnchanged materially since 2006. However,rnFannie Mae has authorized a number of variances that have impacted thosernunderwriting standards and the numbers of these have fluctuated substantiallyrnover time. In 2005 when standards werernloose, Fannie Mae authorized over 11,000 variances. Between January 2005 and August 2007, FanniernMae began rescinding variances, which tightened underwriting standards. Fannie Mae had over 600 variances as ofrnSeptember 2011. These variances from underwriting standards effectively relaxrnthose standards and this contributed to the credit losses and credit-relatedrnexpenses suffered by Fannie Mae in recent years.</p
As an alternative to qualifying mortgagernloans for Fannie Mae’s purchase by manually meeting its underwriting standardsrn(or authorized variances from them), most lenders rely on automatedrnunderwriting software. Fannie Mae hasrndeveloped its own software, DU, which lenders use to evaluate whetherrnprospective mortgage loans are eligible for sale to the Enterprise. In 2010, over 1,500 lenders used DU, and overrn71% of the loans delivered to Fannie Mae were approved using the software. Lenders may also develop their ownrnunderwriting software, but Fannie Mae must approve and grant a variance for itsrnuse.</p
Fannie Mae’s single-family mortgagernbusiness involves a nationwide network of approximately 2,500 approved mortgagernlenders and servicers. From January tornOctober 2011, Fannie Mae acquired over 2 million loans valued at over $427rnbillion. To oversee this large venture, FanniernMae has established an oversight process that includes lender/servicerrnassessment, quality assurance review and remediation for purchased loans, andrnfraud detection.</p<ul class="unIndentedList"
As conservator, FHFA assumed all of thernpowers of the GSEs’ shareholders, directors, and officers. In November 2008, FHFA delegated day-to-dayrndecision-making back to the GSEs’ officers and directors while identifyingrnparticular activities that required its approval including those that involverncapital stock, dividends, increased risk limits, material changes in accountingrnpolicy or reasonably foreseeable increases in operational risk and those thatrnwill likely cause significant reputational risk.</p
In July 2009, FHFA further refined itsrnrole with a regulation clarifying its delegation of day-to-day decision-makingrnauthority. The regulation requires FHFArnapproval of all new GSE products and activities but states that “new products”rndo not include any modification to underwriting criteria for those mortgagesrnpurchased or guaranteed by the GSEs.</p
OIG found that FHFA does not have arnformal process for reviewing underwriting standards and variances but itrninformally reviews and comments on Fannie Mae’s proposed credit policyrnchanges. However, FHFA’s reviewrnmechanism was not designed to assess underwriting standards and variances andrndoes not assess them in a systematic manner.</p
FHFA also reviews, comments on, andrnapproves Fannie Mae’s Corporate Scorecard. OIG says that the scorecard is not arnsubstitute for a detailed consideration of underwriting standards and variancesrnand that Fannie Mae’s Corporate Scorecard for 2012 does not include explicitrngoals for underwriting standards.</p
In contrast to FHFA’s decision not tornaffirmatively review underwriting standards, the FHFA believes that feedbackrnand approval of the Corporate Scorecard is an appropriate conservatorship action. However, underwriting standards and variancesrncontrol the mortgages that Fannie Mae acquires, not the scorecard’s goals, andrnthere are many factors that contribute to the better performance of recentrnmortgage vintages.</p
OIG concluded that FHFA can strengthenrnits oversight by creating formal processes for reviewing both GSEs’ underwriting standards and variancesrnfrom them and enhance is guidance for planning and conducting its examinationsrnof the GSEs’ underwriting quality control.</p
To summarize, OIG’s audit determined thernfollowing:</p<ol
FHFA’srntargeted examinations that included Fannie Mae’s quality control of compliancernwith underwriting standards which began in 2011 is a positive step butrnadditional guidance is needed to ensure the success of underwritingrnexaminations going forward which should include criteria for independentrntesting of quality control.</p
Additionally,rnFHFA’s most recent quarterly risk assessment cited credit risk as a criticalrnconcern due in part to the high volume of seriously delinquent loans. This number seems to be declining and laterrnvintage loans are performing well but credit risk is noted to be increasing duernto Fannie Mae’s RefiPlus program with its high LTV ratios. The new HARP program may exacerbate thisrnrisk. FHFA needs to address the increasingrncredit risk through development of comprehensive examination guidance.</p
FanniernMae also continues to authorize over 600 variances yet FHFA does not formallyrnreview them and thus is not in a position to appreciate their nature andrnscope. Obtaining information about thernvariances would help to educate FHFA about existing increased credit risk andrnmay improve examination guidance.</p
Following its audit, FHFA recommendsrnthat: </p<ul class="unIndentedList"<liFHFA'srnDivision of Housing Mission and Goals formally establish a policy for its reviewrnprocess of underwriting standards and variances including escalation ofrnunresolved issues reflecting potential lack of agreement.</li<liThernDivision of Examination Program and Support enhance existing guidance forrnassessing adherence to underwriting standards and variances from them.</li</ul
In OIG’s opinion, these recommendationsrnapply to FHFA’s responsibilities to Freddie Mac as well as to Fannie Mae.</p
FHFA responded to the OIG report,rnagreeing with both recommendations and identifying proposed actions to addressrnthem and OIG states it found the actions sufficient to resolve thernrecommendations, subject to further review. rn
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Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.
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