oversight

FHFA's Oversight of the Enterprises' Efforts to Recover Losses from Foreclosure Sales

Published by the Federal Housing Finance Agency, Office of Inspector General on 2012-10-17.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                                g
           FEDERAL HOUSING FINANCE AGENCY
      FA’s Oversight of Enterprises’ Management of High-
             OFFICE OF INSPECTOR GENERAL
            Risk Seller/Servicer Counterparty Risk

           FHFA’s Oversight of the Enterprises’ Efforts
            to Recover Losses from Foreclosure Sales




Audit Report: AUD-2013-001                        October 17, 2012
                                                 AT A GLANCE
                                                                  title
  FHFA’s Oversight of the Enterprises’ Efforts to Recover Losses from Foreclosure Sales

Why FHFA-OIG Did This Audit                                      title What FHFA-OIG Found
The Federal National Mortgage Association (Fannie Mae) and       title FHFA has an opportunity to provide the Enterprises with
the Federal Home Loan Mortgage Corporation (Freddie Mac)                  guidance about effectively pursuing and collecting
(collectively, the Enterprises) support the secondary mortgage            deficiencies from targeted groups of borrowers who may
market by buying residential mortgages and securitizing most of           possess the ability to repay. Yet, FHFA does not currently
them. Typically, when borrowers default on these mortgages                oversee the Enterprises’ deficiency management. Further,
and efforts to cure the defaults fail or do not materialize, the          FHFA does not gather information about the Enterprises’
properties are foreclosed upon and eventually sold. The                   deficiency management practices and does not obtain data
purchase price, though, may not be enough to pay off the entire           about the scope or effectiveness of their deficiency
outstanding mortgage balance on the property and the resulting            recoveries. Consequently, the Agency is not well
shortfall is known as a deficiency. The Enterprise that owned             positioned to determine the benefit that stronger Agency
or guaranteed the particular mortgage then absorbs the loss.              oversight may provide.
In 2008, the Enterprises entered conservatorships overseen by             Each Enterprise has developed its own deficiency
the Federal Housing Finance Agency (FHFA or Agency) as a                  management approach. For example, Fannie Mae has its
result of their deteriorating financial conditions.                       vendors pursue deficiencies in more than twice as many
Simultaneously, the U.S. Department of the Treasury                       states as Freddie Mac does. The Enterprises also take
(Treasury) began investing taxpayer funds—more than $187                  different approaches to determining which deficiencies to
billion to date—in the Enterprises to cover their losses.                 pursue. For example, Freddie Mac delegates the decision
                                                                          to its vendors, but Fannie Mae maintains oversight of its
If the Enterprises can recover mortgage deficiencies, then they
                                                                          vendors’ methodology. Also, Freddie Mac does not
can mitigate some of their losses. For example, with respect to
                                                                          pursue deficiencies when third parties buy foreclosures,
borrowers who may currently or in the future possess the
                                                                          whereas Fannie Mae does. In addition, Fannie Mae has
ability to repay—such as, but not limited to, owners of
                                                                          announced an initiative that focuses on borrowers it
investment properties or vacation homes who have defaulted
                                                                          identifies as having defaulted on their mortgages despite
for strategic reasons—pursuing deficiency collections and
                                                                          having the ability to pay—i.e., strategic defaulters. FHFA
judgments may provide an added source of revenue for the
                                                                          may be able to help the Enterprises recoup future losses
Enterprises. In addition, pursuit against such borrowers may
                                                                          through strengthened oversight and guidance.
deter others who are considering default despite being
financially able to make their mortgage payments. However,
during 2011, the Enterprises recovered only a small fraction of           What FHFA-OIG Recommends
the deficiencies they pursued—approximately $4.7 million                  FHFA-OIG recommends that FHFA obtain information
collected out of $2.1 billion pursued.                                    sufficient to analyze how the Enterprises manage
                                                                          deficiencies and issue guidance to them regarding the
FHFA’s Office of Inspector General (FHFA-OIG) undertook
                                                                          topic. Based on the results of its analysis, FHFA should
this audit to assess FHFA’s oversight of the Enterprises’
                                                                          incorporate deficiency management into its Enterprise
deficiency management. In a future audit, FHFA-OIG plans to
                                                                          oversight.
assess the Enterprises’ different practices and their relative
effectiveness in recovering deficiencies.                                 FHFA provided comments agreeing with the
                                                                          recommendations in this report.



Audit Report: AUD-2013-001                                                                                     October 17, 2012
                                       TABLE OF CONTENTS

TABLE OF CONTENTS ................................................................................................................ 3
ABBREVIATIONS ........................................................................................................................ 4
PREFACE ....................................................................................................................................... 5
BACKGROUND ............................................................................................................................ 7
   Default and Foreclosure Overview ............................................................................................. 7
   Foreclosure Sale Deficiencies and State Deficiency Judgments ................................................ 9
   Enterprises’ Deficiency Management ....................................................................................... 10
   FHFA’s Oversight of Enterprises’ Deficiency Management .................................................... 12
FINDING ...................................................................................................................................... 14
CONCLUSION ............................................................................................................................. 15
RECOMMENDATIONS .............................................................................................................. 15
OBJECTIVE, SCOPE, AND METHODOLOGY ........................................................................ 16
APPENDIX A: FHFA’s Comments on Finding and Recommendations .................................... 18
APPENDIX B: FHFA-OIG’s Response to FHFA’s Comments ................................................. 22
APPENDIX C: Summary of Management’s Comments on the Recommendations ................... 23
ADDITIONAL INFORMATION AND COPIES ........................................................................ 24




     Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                                       3
ABBREVIATIONS
Fannie Mae......................................................................... Federal National Mortgage Association

FHFA or Agency.......................................................................... Federal Housing Finance Agency

FHFA-OIG ...................................... Federal Housing Finance Agency Office of Inspector General

Freddie Mac .................................................................. Federal Home Loan Mortgage Corporation

HERA.......................................................................Housing and Economic Recovery Act of 2008

HAMP ...............................................................................Home Affordable Modification Program

HUD .................................................................... Department of Housing and Urban Development

Treasury ........................................................................................ U.S. Department of the Treasury




    Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                               4
PREFACE
The Housing and Economic Recovery Act of 2008 (HERA), which amended the Inspector
General Act of 1978, established FHFA-OIG.1 FHFA-OIG is authorized to conduct audits,
evaluations, investigations, and other law enforcement activities pertaining to FHFA’s programs
and operations. FHFA-OIG is also authorized to recommend policies that promote economy and
efficiency or the prevention and detection of fraud and abuse.

This audit report is part of FHFA-OIG’s mission to promote the economy, efficiency, and
effectiveness of FHFA’s programs and, in accordance with its first strategic goal,2 adds value by
helping the Agency improve the Enterprises’ economic health. Specifically, the report is
intended to strengthen FHFA’s oversight of how the Enterprises manage losses on single-family
foreclosure sales. Better management of these losses—focused on those debtors who possess the
ability to repay—may lead to opportunities to recover a larger portion of the Enterprises’ single-
family foreclosure deficiencies. That is important in light of taxpayers having invested over
$187 billion to help stabilize the Enterprises and prevent their insolvency.

FHFA-OIG believes that its recommendations for enhancing the Agency’s oversight of the
Enterprises’ deficiency management processes should not be construed as encouragement to
aggressively pursue borrowers who do not have the ability to pay their mortgages. Instead, the
Agency should obtain information to better understand the Enterprises’ deficiency management
processes and assess whether further improvements are needed to ensure the Enterprises are
efficiently and effectively managing their credit loss mitigation activities.

Several other FHFA-OIG audits and evaluations also demonstrate the benefit of FHFA
proactively supervising the Enterprises. These include FHFA-OIG’s separate assessments of the
Agency’s oversight of Enterprise activities related to loan repurchase settlements, mortgage
servicing contractors, and single-family underwriting standards.3 Further, FHFA-OIG plans to
assess in a future audit the effect that the Enterprises’ different practices have on their
effectiveness in recovering deficiencies.




1
    HERA: Public Law No. 110-289; Inspector General Act of 1978: Public Law No. 95-452.
2
 See FHFA-OIG, Strategic Plan: Fiscal Years 2012 – 2014, available at
http://www.fhfaoig.gov/Content/Files/Strategic%20Plan_0.pdf.
3
 See FHFA-OIG, Evaluation of the Federal Housing Finance Agency’s Oversight of Freddie Mac’s Repurchase
Settlement with Bank of America (EVL-2011-006, September 27, 2011); FHFA-OIG, FHFA’s Supervision of
Freddie Mac’s Controls over Mortgage Servicing Contractors (AUD-2012-001, March 7, 2012); and FHFA-OIG,
FHFA’s Oversight of Fannie Mae’s Single-Family Underwriting Standards (AUD-2012-003, March 22, 2012).


      Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                       5
FHFA-OIG appreciates the cooperation of everyone who contributed to the audit, including
officials at Fannie Mae, Freddie Mac, and FHFA. This audit was led by Heath Wolfe, Assistant
Inspector General for Audits, and Alisa Davis, Audit Manager.




Russell A. Rau
Deputy Inspector General for Audits




   Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                6
BACKGROUND
The Enterprises support the secondary mortgage market by purchasing residential mortgage
loans from sellers that can then use the proceeds to make more loans. The Enterprises may hold
the mortgages they purchase as their own investments or bundle them into mortgage-backed
securities in which the underlying loans are guaranteed against default. The securities are then
sold to other investors.

In 2007 and 2008, the U.S. housing market suffered its worst downturn since the Great
Depression, and the Enterprises lost billions of dollars. In the midst of this financial crisis,
FHFA was established by HERA and was authorized to oversee the Enterprises by, among other
means, conducting examinations and developing regulations. HERA also expanded the authority
of Treasury to provide financial support to the Enterprises.

In September 2008, as the Enterprises’ losses mounted, they entered into conservatorships
overseen by FHFA. As conservator, FHFA is responsible for preserving and conserving the
Enterprises’ assets and restoring them to a sound financial condition. Accordingly, FHFA’s
purview includes Enterprise loss mitigation activities such as recovering deficiencies—i.e., the
difference between the proceeds of foreclosure sales and the higher balances of the foreclosed
mortgages. Additionally, as of June 30, 2012, Treasury has invested over $187 billion in the
Enterprises to offset their losses and prevent their insolvency.4

In what follows, FHFA-OIG discusses how the Enterprises manage their deficiencies. After
presenting a general overview of mortgage defaults and foreclosures, this Background section
describes how deficiencies can be collected, focuses on the differences between how the
Enterprises manage their deficiencies, and then summarizes FHFA’s oversight activities. The
Finding section considers the potential for improvements in the Enterprises’ deficiency
management activities and highlights the importance of FHFA’s oversight.

        Default and Foreclosure Overview

When borrowers take out mortgages, they make contractual commitments to pay them on time
and in full. Typically, borrowers continue to honor their commitments—if they are financially
able to do so—even when they owe more than their properties are worth (i.e., they are


4
  Specifically, pursuant to Senior Preferred Stock Purchase Agreements, the Enterprises request and obtain funds
from Treasury, which owns preferred stock in each Enterprise. Under the agreements, the liquidation value of
Treasury’s stock increases as the Enterprises obtain additional Treasury funds, and—in exchange for Treasury’s
investment—the Enterprises must consult with Treasury concerning a variety of significant business activities,
capital stock issuance and dividend payments, ending the conservatorships, transferring assets, and awarding
executive compensation.


    Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                         7
“underwater”).5 However, when borrowers miss a payment, their mortgage loans are considered
delinquent.

Ordinarily, when borrowers fail to make mortgage payments for 90 days they are considered
seriously delinquent. In such cases, the Enterprises, acting through their mortgage servicers,
may work with borrowers to resolve the delinquency.6 For example, the Enterprises may offer
loan modifications to lower borrowers’ monthly payments through programs such as Treasury’s
Home Affordable Modification Program (HAMP).7

If these efforts prove unsuccessful, the Enterprises may initiate foreclosure proceedings. In
general, foreclosure proceedings begin when the mortgage servicer files a lawsuit against the
homeowner or notifies the homeowner of the initiation of foreclosure proceedings. If the
homeowner cannot cure the default—i.e., pay what is due and owing—then the process may
culminate in an auction known as a foreclosure sale.

At the foreclosure sale, the owner of the mortgage, such as an Enterprise via its servicer, may
make an offer on the property and take possession if it is the highest bidder. Alternatively, a
third party, such as an investor, may win the bid and take ownership. In 2011, there were
341,738 foreclosure sales of properties that secured Enterprise-owned or -guaranteed mortgages.
The Enterprises bought 298,327 of those foreclosures (about 87%) and third parties bought the
remaining 44,247 (about 13%).8

Some borrowers default because they no longer possess the ability to repay their mortgage loans.
However, there is a group of borrowers who may continue to possess the ability to repay but who
elect to default for strategic reasons. These borrowers are commonly referred to as “strategic
defaulters.” For purposes of this report, strategic defaulters have the financial means to make




5
  For example, according to FHFA, approximately 80% of the Enterprises’ underwater borrowers are current on
their loans. See FHFA, Review of Options Available for Underwater Borrowers and Principal Forgiveness, p. 3
(July 31, 2012).
6
 A mortgage servicer, such as a commercial bank subsidiary or affiliate, may perform a variety of functions for an
Enterprise. These functions include collecting principal and interest payments from borrowers, forwarding the
mortgage payments to the owners of the loans, maintaining escrow accounts, and performing default-related
services, including sending notifications to delinquent borrowers and, if necessary, initiating foreclosure
proceedings.
7
 See generally, FHFA-OIG, Evaluation of FHFA’s Role in Negotiating Fannie Mae’s and Freddie Mac’s
Responsibilities in Treasury’s Making Home Affordable Program (EVL-2011-003, August 12, 2011).
8
    According to an FHFA official, the difference (i.e., 44,247 vs. 43,411) is due to the timing of different data sets.


       Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                              8
their monthly mortgage payments, but choose not to and walk away from their contractual
commitments to pay.9

One potential class of strategic defaulter—i.e., borrowers who purchased vacation homes or
purchased residential real estate for investment purposes—appears to be significant. As reflected
in Figure 1 below, between 2003 and 2007, approximately two million or more
vacation/investment homes were purchased each year.

                                        Figure 1: Home Sales by Use, 2003-200710




           Foreclosure Sale Deficiencies and State Deficiency Judgments

There are times when the proceeds from a foreclosure sale may be less than the borrower’s
mortgage loan balance.11 For example, a home’s current value/sales price may fall below the
borrower’s mortgage loan balance, so that the foreclosure sale does not make the lender


9
 The definition of “strategic defaulter” may vary. For example, FHFA defines “strategic defaulters” in its Review of
Options Available for Underwater Borrowers and Principal Forgiveness as borrowers who default on their
underwater mortgages “without apparent disruption to their other financial obligation” (p. 3).
10
  Source: The Role of Non-Owner-Occupied Homes in the Current Housing and Foreclosure Cycle, The Federal
Reserve Bank of Richmond (WP 10-11), available at http://www.richmondfed.org/publications/research/working-
_papers/2010/pdf/wp10-11.pdf (accessed September 4, 2012).
11
     The mortgage balance may include accrued interest as well.


       Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                           9
financially whole. Such deficiencies may also arise when the costs associated with the
foreclosure process, including attorney’s fees, exceed the foreclosure recovery amount. If
foreclosure sale proceeds are not sufficient to cover the borrower’s debt, the mortgage owner,
such as an Enterprise, is left either to absorb the deficiency as a loss or to try to collect it from
the borrower.

Rules governing foreclosure processes and attempts to collect deficiency amounts vary by state.
These state laws govern whether the foreclosure process is handled through the courts (i.e.,
judicial foreclosure) or without a court order (i.e., non-judicial foreclosure). State laws also
dictate whether a mortgage owner has recourse to pursue collection of a deficiency.12 The
Enterprises can pursue deficiencies via voluntary debt collection efforts or through the legal
system; however, the Enterprises generally must obtain judgments in court to make borrowers
pay the deficiencies.

Some states restrict deficiency judgments and may be considered to be non-recourse states. For
example, one state does not permit deficiency judgments if the foreclosed property is residential,
on less than 2.5 acres, and intended as a home for one or two families. Further, in states where
lenders have recourse against delinquent borrowers, lenders typically must credit borrowers for
at least their properties’ fair market values, which may be higher than foreclosure sale prices.
This variance among state laws influences the Enterprises’ approaches to managing their
deficiencies.

        Enterprises’ Deficiency Management

Neither Enterprise pursues recoveries on deficiencies as a primary loss mitigation strategy.
Instead, the Enterprises assert that they focus on foreclosure alternatives to minimize losses.
These alternatives include avoiding foreclosures through loan modifications (e.g., HAMP).13
However, when these efforts fail and foreclosure sale proceeds are not enough to pay off
mortgage balances, the Enterprises may either absorb the deficiencies as losses; direct collection




12
 Here and below, details are drawn from Andra C. Ghent and Marianna Kudlyak, Recourse and Residential
Mortgage Default: Theory and Evidence from U.S. States, Federal Reserve Bank of Richmond Working Paper
No. 09-10 (July 7, 2009).
13
  For more information on the foreclosure process, see FHFA-OIG, An Overview of the Home Foreclosure Process,
available at http://www.fhfaoig.gov//Content/Files/SAR%20Home%20Foreclosure%20Process.pdf. For more
information on the Enterprises’ real estate owned process and activity, see FHFA-OIG, Overview of the Risks and
Challenges the Enterprises Face in Managing Their Inventories of Foreclosed Properties (WPR-2012-003, June 14,
2012).


     Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                      10
vendors to pursue voluntary collections from borrowers; or obtain court-ordered deficiency
judgments.14

Officials at both Enterprises note that, among other factors, state laws, foreclosure timeframes,
and costs influence their decisions to pursue deficiencies. Although external factors impact the
Enterprises the same, their strategies for recouping their losses differ. For example, the
Enterprises differ with respect to the states in which they pursue deficiencies. Fannie Mae has its
vendors pursue deficiency collections and judgments in 38 states and the District of Columbia,
but Freddie Mac’s vendors limit their pursuit to 17 states and the District of Columbia.

The Enterprises also take different approaches in determining which deficiencies to pursue. For
example, Freddie Mac delegates the decision to its vendors, but Fannie Mae maintains oversight
of its vendors’ decision-making methodologies. Also, Freddie Mac does not pursue deficiencies
when third parties buy at foreclosure sales the properties underlying its defaulted mortgages.
Conversely, Fannie Mae pursues deficiencies regardless of whether it or a third party is the
purchaser at a foreclosure sale.

The Enterprises have also adopted different approaches to targeting borrowers who strategically
default yet still have the ability to repay. Fannie Mae has articulated its intention to focus on
strategic defaulters.15 Accordingly, the Enterprise has developed a methodology to identify
potential strategic defaulters and to send this information to its vendors to pursue collection. On
the other hand, Freddie Mac has not established a policy with regard to pursuing deficiency
collections from strategic defaulters.

In 2011, the Enterprises’ vendors pursued 35,231 deficiency accounts, with a combined value of
about $2.1 billion. Of this amount, vendors recouped approximately $4.7 million—about 0.22%.
In a future audit, FHFA-OIG plans to assess the Enterprises’ different practices and their relative
effectiveness in recovering deficiencies.




14
 The Enterprises’ losses on deficiencies may potentially be offset by, among other things, repurchases and
mortgage insurance.
15
  Over two years ago, Fannie Mae announced that it would “take legal action to recoup the outstanding mortgage
debt from borrowers who strategically default on their loans in jurisdictions that allow for deficiency judgments.”
See “Fannie Mae Increases Penalties for Borrowers Who Walk Away; Seven-Year Lockout Policy for Strategic
Defaulters,” Fannie Mae News Release (June 23, 2010), available at http://www.fanniemae.com/portal/about-
us/media/corporate-news/2010/5071.html (accessed August 23, 2012). Fannie Mae also indicated that strategic
defaulters henceforth would be ineligible for a Fannie Mae-owned or -guaranteed loans for seven years.


     Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                         11
The Enterprises’ current recovery rate and the potential increase in foreclosures16 present FHFA,
as conservator, with an opportunity to ensure through its oversight that the Enterprises are
benefitting from effective deficiency management.

FHFA’s Oversight of Enterprises’ Deficiency Management

FHFA has not issued comprehensive guidance to the Enterprises regarding deficiency
management. However, the Agency has considered questions related to deficiencies in
connection with other issues. For example, the Agency recently announced changes to short sale
policies that include a prohibition against the Enterprises pursuing deficiency judgments against
military personnel, who own homes purchased before June 30, 2012, and are ordered to change
duty stations.17 FHFA has also considered the impact of deficiency judgments on the default risk
associated with residential mortgage loans.18 Specifically, FHFA agreed with research
concluding: “Even if lenders seldom (or never) pursue deficiency judgments in court, losses are
lower when the threat of recourse can be exercised credibly.”19 Nonetheless, FHFA has not
conducted an overall assessment of the Enterprises’ deficiency judgment practices to determine
if guidance for the Enterprises is warranted.

In contrast, other federal agencies with national housing responsibilities have issued guidance on
deficiencies for lenders under their jurisdiction. The guidance covers areas such as which
borrowers to pursue and what cost-benefit rationales to consider. For example, the
U.S. Department of Agriculture, which administers rural housing development programs, advises
that deficiency judgments should only be pursued (in allowable states) when borrowers have
sufficient assets for recovery.20 Similarly, the Department of Housing and Urban Development
(HUD) issued guidance about pursuing mortgage deficiencies;21 HUD emphasized seeking
16
  FHFA-OIG recently reported that as of December 31, 2011, the Enterprises owned or guaranteed over 1.1 million
seriously delinquent mortgages. See FHFA-OIG, Overview of the Risks and Challenges the Enterprises Face in
Managing Their Inventories of Foreclosed Properties (WPR-2012-003, June 14, 2012).
17
  “FHFA Announces Short Sale Assistance for Military Homeowners with Fannie Mae or Freddie Mac Loans,”
FHFA News Release (June 21, 2012), available at http://www.fhfa.gov/webfiles/24026/CFPBFinalw-FS.pdf
(accessed August 9, 2012).
18
  FHFA, Default Risk Evaluation in the Single-Family Mortgage Market (October 2009), available at
http://www.fhfa.gov/webfiles/15151/10-30-09_FHFA_Default_Risk_Evaluation_Report.pdf%20uses%20
October%2030 (accessed September 9, 2012).
19
     Id., p. 6.
20
  USDA Handbook HB-1-3550, available at http://www.rurdev.usda.gov/SupportDocuments/
3550-1chapter13.pdf (accessed on June 29, 2012).
21
   HUD guidance is available from the following sources: HUD Mortgagee Letter 89-14, available at
http://www.hud.gov/offices/adm/hudclips/letters/mortgagee/files/89-14ml.txt (accessed on April 9, 2012); HUD
Mortgage Notice H-94-89, available at http://www.hud.gov/offices/adm/hudclips/notices/hsg/files/94-89HSGN.doc
(accessed on June 29, 2012); and HUD Mortgage Letter 90-15, available at http://www.hud.gov/offices/adm/hud-
clips/letters/mortgagee/files/90-15ml.txt (accessed on August 15, 2012).


       Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                      12
deficiency judgments against strategic defaulters who abandon their mortgage payment
obligations despite their apparent continued ability to repay.

In general, FHFA performs supervisory reviews, including offsite monitoring and targeted
examinations. In the finding that follows, FHFA-OIG outlines the Agency’s opportunity to
incorporate deficiency management into its supervisory review process.




   Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                               13
FINDING
       FHFA Can Better Supervise the Enterprises’ Deficiency Management by Obtaining
       Deficiency Data and Providing Guidance

Recovering losses from strategic defaulters and others who have the ability to repay their
financial obligations—e.g., real estate investors and vacation home owners—presents an
opportunity for the Enterprises to strengthen their financial positions and to reduce the need for
future taxpayer support. As conservator, FHFA is responsible for preserving and conserving the
Enterprises’ assets and restoring them to a sound financial condition. Accordingly, FHFA
should obtain information necessary to better understand the Enterprises’ deficiency activities
and to determine where improvements can be made.

The Enterprises manage their foreclosure deficiencies in a challenging environment. For
example, the Enterprises must navigate diverse legal regimes to pursue deficiencies. Although
borrowers make contractual commitments to repay their mortgage loans, individual state laws
can diminish or effectively eliminate the Enterprises’ ability to recover any shortfalls arising
from such commitments, even when borrowers can repay the balance of their mortgage loans.

FHFA has not taken a proactive approach to its oversight of the Enterprises’ deficiency
management practices to maximize recoveries when appropriate. For example, the Agency has
not published guidance for the Enterprises on the subject and has not conducted any continuous
supervision to monitor and analyze trends and risks associated with deficiencies. The Agency
also has not conducted targeted examinations of deficiency management that could offer detailed
information about specific risks, supervisory concerns, etc. Further, FHFA does not require the
Enterprises to provide deficiency data. For instance, the Agency does not solicit information
about the scope of the Enterprises’ deficiencies, the number or amount of their collection
referrals, or their recovery rate. As a result, the Agency cannot track or evaluate their collection
practices and recovery rates, and thus FHFA cannot readily conclude whether the Enterprises’
low recovery rate—0.22%—is reasonable, or if their deficiency recoveries could be improved.

FHFA has not devoted particular attention to the Enterprises’ deficiency management practices
because it does not view the area as high-risk. In contrast, other Federal agencies with national
housing responsibilities have issued guidance that standardizes how lenders under their
jurisdiction should handle deficiencies—e.g., identifying which borrowers to pursue and what
cost-benefit rationales to consider.

In the absence of meaningful FHFA oversight, each Enterprise has developed its own deficiency
management approach. Yet, without specific supervision and guidance from FHFA, the
Enterprises may not fully realize their recovery potential or ensure that they are meeting their
obligations to mitigate losses using all available tools.

   Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
                                                 14
CONCLUSION
Given a recovery rate of 0.22%, the Enterprises appear to have room for improvement in how
they manage their deficiencies. Further, with 1.1 million seriously delinquent mortgages
looming on the foreclosure horizon—triple the Enterprises’ foreclosures in 2011—FHFA’s
timely guidance on deficiency management processes may help the Enterprises recoup future
losses and protect taxpayers’ investment in their financial health.22

RECOMMENDATIONS
FHFA-OIG recommends that FHFA:

     1. Routinely obtain deficiency-related information, such as the size of the Enterprises’
        deficiencies, their effectiveness in targeting for deficiency collection defaulting
        borrowers who continue to have the ability to repay their loans, the number or amount of
        their collection referrals, and their recovery rate.
     2. Based on an analysis of deficiency data from Recommendation 1, incorporate deficiency
        management into FHFA’s supervisory review process.
     3. Issue written guidance to the Enterprises on managing their deficiency collection
        processes, including at a minimum whether they should be pursuing the same type of
        defaulted borrowers and pursuing collections in the same states.




22
  For more detailed discussion of foreclosure related risks, see FHFA-OIG, Overview of the Risks and Challenges
the Enterprises Face in Managing Their Inventories of Foreclosed Properties (WPR-2012-003, June 14, 2012).


     Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
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OBJECTIVE, SCOPE, AND METHODOLOGY
The objective of this performance audit was to assess FHFA’s oversight of the Enterprises’
management of deficiency recoveries related to foreclosed, single-family residential mortgages.
Specifically, FHFA-OIG sought to review the extent and effectiveness of FHFA’s oversight of
the Enterprises’ deficiency management processes.

In March 2012, FHFA-OIG initiated a survey to assess FHFA’s oversight of the Enterprises’
management of deficiency judgments. In June 2012, FHFA-OIG completed the survey and
announced an audit with the modified objective set forth above. The scope of the audit was
January 2010 through June 2012, and was expanded as necessary.

FHFA-OIG performed fieldwork for this audit from June 2012 through August 2012. FHFA-
OIG conducted its fieldwork at FHFA’s offices in Washington, D.C., Fannie Mae’s corporate
offices in Washington, D.C., and Freddie Mac’s corporate offices in McLean, Virginia. To
achieve the objective, FHFA-OIG identified deficiency management guidance used by federal
banking/lending regulatory agencies or applicable to government-insured mortgages; interviewed
FHFA and Enterprise officials; reviewed FHFA supervision and examination policies, plans, and
results; and reviewed Enterprise deficiency management processes, procedures, servicing guides,
and related documents.23

FHFA-OIG assessed the internal controls related to the audit objective. Specifically, FHFA-OIG
evaluated the following control standards that were significant to the audit objective: risk
assessment, information and communication, and monitoring. Internal controls are an integral
component of an organization’s management that provide reasonable assurance that the
following objectives are achieved: (1) effectiveness and efficiency of operations; (2) reliability
of financial reports; and (3) compliance with applicable laws and regulations. Internal controls
relate to management’s plans, methods, and procedures used to meet its mission, goals, and
objectives, and include the processes and procedures for planning, organizing, directing, and
controlling program operations as well as the systems for measuring, reporting, and monitoring
program performance. Based on the work completed on this performance audit, FHFA-OIG
considers its finding on FHFA’s oversight of the Enterprises’ deficiency management to be
significant in context of the audit objective.



23
  The federal banking/lending regulatory agencies include the Office of the Comptroller of the Currency (inclusive
of the Office of Thrift Supervision), the Federal Deposit Insurance Corporation, and the Federal Reserve Board of
Governors. Agencies with authorities related to government-insured mortgages include the Federal Housing
Administration, the Department of Veterans Affairs, and the U.S. Department of Agriculture’s Rural Housing
Service.


     Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
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FHFA-OIG conducted this performance audit in accordance with Generally Accepted
Government Auditing Standards. Those standards require that audits be planned and performed
to obtain sufficient, appropriate evidence to provide a reasonable basis for FHFA-OIG’s finding
and conclusions based on the audit objective. FHFA-OIG believes that the evidence obtained
provides a reasonable basis for the finding and conclusions included herein, based on the audit
objective.




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APPENDIX A:
FHFA’s Comments on Finding and Recommendations




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Federal Housing Finance Agency Office of Inspector General • AUD-2013-001 • October 17, 2012
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APPENDIX B:
FHFA-OIG’s Response to FHFA’s Comments

On September 20, 2012, FHFA provided comments to a draft of this report, agreeing with all
recommendations and identifying FHFA actions to address them. FHFA-OIG considers the actions
sufficient to resolve the recommendations, which will remain open until FHFA-OIG determines that
agreed-upon corrective actions are completed and responsive to the recommendations. FHFA-OIG has
attached the Agency’s full response (see Appendix A), which was considered in finalizing this report.
Appendix C provides a summary of management’s comments on the recommendations and the status of
agreed-to corrective actions.




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APPENDIX C:
Summary of Management’s Comments on the Recommendations
This table presents management’s responses to the recommendations in FHFA-OIG’s report and
the status of each recommendation as of when the report was issued.

                                                          Expected
      Rec.        Corrective Action: Taken or            Completion      Monetary      Resolved:       Open or
      No.                   Planned                          Date        Benefits      Yes or Noa      Closedb
       1.     FHFA will develop a framework for the       4/13/2013        $0             Yes            Open
              type of deficiency-related information
              that would be most useful in estimating
              potentially recoverable amounts and
              work with the Enterprises to define the
              type of information that they will
              routinely gather. FHFA has undertaken
              reviews of current deficiency reporting
              procedures at the Enterprises and will
              build on that work in creating a useful
              reporting template. FHFA will also
              share information received among its
              regulatory, conservator, and strategy
              divisions.
       2.     FHFA will include the Enterprises’             7/15/2013       $0            Yes           Open
              deficiency collections in its
              supervisory strategy.
       3.     FHFA will issue guidance to the                9/20/2013       $0            Yes           Open
              Enterprises on deficiency
              management.
     Total                                                                   $0


a
 Resolved means: (1) Management concurs with the recommendation, and the planned, ongoing, or completed
corrective action is consistent with the recommendation; (2) Management does not concur with the recommendation,
but alternative action meets the intent of the recommendation; or (3) Management agrees to the FHFA-OIG
monetary benefits, a different amount, or no amount ($0). Monetary benefits are considered resolved as long as
management provides an amount.
b
  Once FHFA-OIG determines that agreed-upon corrective actions have been completed and are responsive, the
recommendations can be closed.




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ADDITIONAL INFORMATION AND COPIES

For additional copies of this report:

       Call the Office of Inspector General: 202-730-0880

       Fax your request: 202-318-0239

       Visit FHFA-OIG’s website: www.fhfaoig.gov



To report alleged fraud, waste, abuse, mismanagement, or any other kind of criminal or
noncriminal misconduct relative to FHFA’s programs or operations:

       Call our Hotline: 1-800-793-7724

       Fax your written complaint: 202-318-0358

       Email us: oighotline@fhfaoig.gov

       Write us: FHFA Office of Inspector General
                 Attn: Office of Investigation – Hotline
                 400 Seventh Street, S.W.
                 Washington, DC 20024




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