oversight

FHFA Can Improve Its Oversight of Freddie Mac's Recoveries from Borrowers Who Possess the Ability to Repay Deficiencies

Published by the Federal Housing Finance Agency, Office of Inspector General on 2013-09-24.

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

          Federal Housing Finance Agency
              Office of Inspector General




FHFA Can Improve Its Oversight of
  Freddie Mac’s Recoveries from
Borrowers Who Possess the Ability to
        Repay Deficiencies




Audit Report  AUD-2013-010  September 24, 2013
                FHFA Can Improve Its Oversight of Freddie Mac’s
                Recoveries from Borrowers Who Possess the Ability to
                Repay Deficiencies
                Why OIG Did This Report
                The Federal Home Loan Mortgage Corporation (Freddie Mac or the enterprise) has
                been in a conservatorship under direction of the Federal Housing Finance Agency
Synopsis        (FHFA or the agency) since September 2008 and has received over $71 billion in
                taxpayer assistance. Between its placement in conservatorship and December 2012,
   ———          there have been more than 460,000 foreclosures of single-family residential mortgages
                owned or guaranteed by Freddie Mac. Further, the enterprise owned 49,071 foreclosed
September 24,   properties with a carrying value of $4.3 billion as of December 2012. As of March 31,
    2013        2013, it also owned a substantial shadow inventory: 364,000 mortgages with
                payments that are 60 days or more delinquent and are likely foreclosure candidates.
                If either the foreclosure sale’s proceeds or the value at which Freddie Mac records a
                property in its real estate owned portfolio is less than the borrower’s mortgage loan
                balance, the shortfall (or deficiency) represents a loss to Freddie Mac. Such losses can
                be reduced if the enterprise recovers deficiencies from borrowers who possess the
                ability to repay. Enhanced deficiency management practices can also serve as a
                deterrent to those who would choose to strategically default on their mortgage
                obligations.
                In October 2012, the FHFA Office of Inspector General (OIG) issued a report that
                assessed the agency’s oversight of the deficiency management efforts of Freddie Mac
                and the Federal National Mortgage Association (Fannie Mae) (collectively, the
                enterprises). In that audit, OIG found that FHFA had an unfulfilled opportunity to
                provide the enterprises with guidance about effectively pursuing and collecting
                deficiencies from borrowers who may possess the ability to repay. In this audit, OIG
                focused in more detail on Freddie Mac’s deficiency recovery practices for borrowers
                who possess the ability to pay amounts owed on foreclosed mortgages owned or
                guaranteed by the enterprise.

                What OIG Found
                OIG concluded that FHFA can improve its oversight of Freddie Mac’s deficiency
                recovery processes. OIG based this conclusion on two facts. First, OIG found that
                Freddie Mac did not refer nearly 58,000 foreclosures with estimated deficiencies of
                approximately $4.6 billion to its deficiency collection vendors (vendors) to evaluate
                the borrowers’ ability to repay those deficiencies. Because the deficiencies were not
                referred for consideration of recovery, the portion of the $4.6 billion that may have
                been collectible is unknown. Further, Freddie Mac eliminated any possibility of
                recovery when it did not refer foreclosed mortgages for evaluation of collectibility.
                Most of these foreclosed mortgages were associated with properties in states where
                Freddie Mac did not pursue deficiencies but where Fannie Mae did, with some
                success. The remainder were foreclosure sales to third parties rather than the
                enterprise; these third-party sales can result in deficiencies but as a practice Freddie
                Mac—unlike Fannie Mae—did not pursue deficiencies arising from third-party sales.
                Second, delays in the vendors’ evaluation process limited Freddie Mac’s opportunity
                to pursue deficiencies related to more than 6,000 foreclosed mortgages for which state
                statutes of limitations had expired. The delay was caused by challenges associated
                with coordinating among Freddie Mac’s various foreclosure/deficiency collection
                counterparties—servicers, attorneys, and vendors. Specifically, the vendors did not

Synopsis        timely receive from the servicers and attorneys the information needed to calculate
                deficiency balances and pursue collection. Without timely evaluating the collectability
   ———          of deficiencies from borrowers with the ability to repay, Freddie Mac reduces the
                chance of recoveries and incentivizes “strategic defaulters” (i.e., those who choose not
September 24,   to meet their contractual obligations to make mortgage payments in spite of their
    2013        ability to do so).

                What OIG Recommends
                OIG recommends that FHFA: (1) evaluate periodically the efficiency and
                effectiveness of Freddie Mac’s deficiency recovery strategies for pursuit of borrowers
                with the ability to repay; (2) review Freddie Mac’s monitoring controls over its
                servicers, foreclosure attorneys, and collection vendors involved in deficiency
                recovery activities to ensure that oversight across these counterparties is maintained;
                (3) direct Freddie Mac to establish and implement controls for its counterparties to
                deliver timely documents to deficiency recovery vendors and provide for financial
                consequences to those counterparties that fail to meet delivery deadlines; and (4)
                direct Freddie Mac to implement a control to consider timeframes in state statutes of
                limitations in prioritizing, coordinating, and monitoring deficiency collection activity
                for borrowers with the ability to repay.
                FHFA provided comments agreeing with the recommendations in this report.
TABLE OF CONTENTS ................................................................

TABLE OF CONTENTS ........................................................................................................................4

ABBREVIATIONS ................................................................................................................................6

PREFACE ...............................................................................................................................................7

CONTEXT ..............................................................................................................................................8
      Previous Audit .................................................................................................................................8
      Deficiency Recovery Process ..........................................................................................................8
              Foreclosure Overview ..............................................................................................................8
              Deficiency Recovery Process Overview..................................................................................9
              Evolution of Freddie Mac’s Deficiency Management Program ............................................11
              Strategic Defaulters................................................................................................................13
      Freddie Mac’s Evaluation of Its Vendors’ Performance ...............................................................13

FINDINGS ............................................................................................................................................15
      1. Freddie Mac Did Not Refer Nearly 58,000 Foreclosures to Its Vendors to
      Evaluate Borrowers’ Ability to Repay ..........................................................................................15
      2. Delays in the Vendors’ Evaluation Process Limited Their Opportunity to Pursue
      Borrowers Who Can Repay ...........................................................................................................17

CONCLUSIONS...................................................................................................................................19

RECOMMENDATIONS ......................................................................................................................19

OBJECTIVE, SCOPE, AND METHODOLOGY ................................................................................20

APPENDIX A .......................................................................................................................................22
      FHFA’s Comments on OIG’s Findings and Recommendations ...................................................22

APPENDIX B .......................................................................................................................................24
      OIG’s Response to FHFA’s Comments ........................................................................................24

APPENDIX C .......................................................................................................................................25
      Status of Agreed-Upon Corrective Actions ...................................................................................25


                                         OIG  AUD-2013-010  September 24, 2013                                                                4
ADDITIONAL INFORMATION AND COPIES ................................................................................27




                               OIG  AUD-2013-010  September 24, 2013                                        5
ABBREVIATIONS .......................................................................

COSO                          Committee of Sponsoring Organizations of the Treadway
                              Commission (COSO)

Enterprises                   Fannie Mae and Freddie Mac

Fannie Mae                    Federal National Mortgage Association

FHFA or agency                Federal Housing Finance Agency

Freddie Mac or enterprise     Federal Home Loan Mortgage Corporation

OIG                           Federal Housing Finance Agency Office of Inspector General

Treasury                      U.S. Department of the Treasury

Vendors                       Deficiency Collection Vendors




                            OIG  AUD-2013-010  September 24, 2013                        6
PREFACE ...................................................................................

This audit report is part of OIG’s mission to promote the economy, efficiency, and
effectiveness of FHFA’s programs and, in accordance with our first strategic goal, adds
value by helping the agency improve the enterprises’ economic health. Specifically, the
report is intended to strengthen FHFA’s oversight of how Freddie Mac manages deficiencies
or losses that result when foreclosure sale proceeds are less than the borrower’s mortgage
loan balance. Better management of these losses—focused on those borrowers who possess
the ability to repay—may lead to opportunities to recover a larger portion of the enterprises’
single-family foreclosure deficiencies.

Additionally, this report supplements OIG’s prior work in the deficiency management area
by assessing the effects of the lack of agency oversight. Specifically, the audit evaluates
Freddie Mac’s processes for determining the ability of borrowers to repay mortgage
deficiencies.

OIG believes that our recommendations for enhancing the agency’s oversight of Freddie
Mac’s deficiency recovery 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 assess whether further improvements are needed to ensure the enterprise
is efficiently and effectively managing its credit loss mitigation activities.

OIG is authorized to conduct audits, evaluations, investigations, and other law enforcement
activities pertaining to FHFA’s programs and operations. As a result of this work, OIG
may recommend policies that promote economy and efficiency in administering FHFA’s
programs and operations, or that prevent and detect fraud, waste, and abuse in them. OIG
believes that this report’s recommendations will increase FHFA’s assurance that the
enterprises are operating safely and soundly and that their assets are preserved and
conserved.

OIG appreciates the cooperation of all those who contributed to this audit, which was led by
Alisa Davis, Acting Assistant Inspector General for Audits. This report has been distributed
to Congress, the Office of Management and Budget, and others, and will be posted on OIG’s
website, www.fhfaoig.gov.




Russell A. Rau
Deputy Inspector General for Audits



                           OIG  AUD-2013-010  September 24, 2013                               7
CONTEXT ..................................................................................

Previous Audit

In an October 2012 report, OIG addressed FHFA’s general lack of oversight of the
enterprises’ processes for recovering deficiencies from borrowers who possess the ability to
repay.1 OIG found that FHFA had an unfulfilled opportunity to provide the enterprises with
guidance about effectively pursuing and collecting deficiencies from targeted groups of
borrowers who may possess the ability to repay. Specifically, FHFA had not examined the
enterprises’ deficiency management practices, provided guidance to them on the subject, or
obtained data about the scope and effectiveness of their deficiency recoveries.

OIG noted that better management of deficiency recoveries—focused on those borrowers
who possess the ability to repay, including strategic defaulters2—can help mitigate losses
and deter strategic defaults.

Deficiency Recovery Process

       Foreclosure Overview

A deficiency could stem from a foreclosure, short sale,3 or deed-in-lieu of foreclosure. For
this audit, OIG will outline the deficiency process associated with foreclosure.

A deficiency typically is established based on what occurs during a foreclosure sale. At such
a sale, the buyer who is the highest bidder acquires the property. However, if a foreclosure
sale’s proceeds are less than the borrower’s mortgage loan balance, then Freddie Mac
absorbs the shortfall, or deficiency, as a loss.4 From September 2008 through December
2012, there were more than 460,000 foreclosure sales of properties that secured Freddie Mac
owned or guaranteed mortgages. These sales resulted in substantial losses to the enterprise.



1
 OIG, FHFA’s Oversight of the Enterprises’ Efforts to Recover Losses from Foreclosure Sales (AUD-2013-
001, October 17, 2012), available at http://www.fhfaoig.gov/Content/Files/AUD-2013-001.pdf.
2
 Strategic defaulters are defined as those who possess the financial means to make their monthly mortgage
payments, but do not do so.
3
 A short sale is the sale of a mortgaged property at a price that nets less than the total amount due on the
mortgage (e.g., the sum of the unpaid principal balance, accrued interest, advanced escrows, late fees, and
delinquency charges). The servicer and borrower negotiate payment of the difference between the net sales
price and the total amount due on the mortgage.
4
    Such a loss can be reduced by mortgage insurance proceeds or a repurchase, if either is applicable.




                                   OIG  AUD-2013-010  September 24, 2013                                     8
Freddie Mac may acquire a foreclosed property based on its bid, and the property becomes
real estate owned. Freddie Mac sends new foreclosures on a monthly basis to its vendors so
they can begin evaluating and pursuing any deficiency from borrowers who can repay based
on information available at the time of the foreclosure sale.

In an effort to recoup some of these losses, Freddie Mac can direct vendors to pursue
voluntary collections from borrowers with the ability to repay or to obtain court-ordered
deficiency judgments. Freddie Mac’s vendors pursued deficiency recoveries on foreclosure
sales when the properties were taken into Freddie Mac’s real estate owned inventory, but—
until recently—they did not pursue deficiency recoveries on foreclosure sales won by third
parties.

Although recovering deficiencies reduces losses, several factors influence the decision to
pursue recovery. In particular, state laws dictate the timeline for filing a deficiency claim or
may prohibit the collection of deficiencies. The statute of limitations establishes the period
during which a creditor can sue a debtor or borrower in this case. Each state has its own
statute of limitations. If the statute of limitations has expired, then payment of the debt owed
cannot be enforced through the courts.

   Deficiency Recovery Process Overview

There are multiple players and steps in the deficiency recovery process. The key players
include:

      Servicers, which collect monthly mortgage payments from borrowers;
      Attorneys, who initiate foreclosure proceedings on behalf of Freddie Mac;
      Freddie Mac, which owns or guarantees the mortgages on the foreclosed properties
       and oversees vendors performing recovery services; and
      Vendors, which evaluate the collectability of the deficiencies and pursue recoveries.

Figure 1 summarizes the deficiency recovery process, and the following paragraphs provide
further details.




                            OIG  AUD-2013-010  September 24, 2013                                9
                                FIGURE 1: DEFICIENCY RECOVERY OVERVIEW




Source: OIG analysis of Freddie Mac’s and its vendors’ policies and practices.

The first two steps in Freddie Mac’s deficiency recovery process involve obtaining and
analyzing monthly foreclosure data. First, Freddie Mac receives from its servicers data on
foreclosure sales that occurred during the month. Second, the enterprise compiles a list of
the foreclosure sales. To prepare this file to send to its collection vendors, Freddie Mac
applies its deficiency management criteria to the foreclosures. These criteria enabled the
enterprise to filter out third-party sales5 and foreclosures in states in which its servicers were
not required to preserve the enterprise’s rights to pursue deficiencies.6 Freddie Mac then
allocates the foreclosures to the vendors to evaluate whether a deficiency exists and should
be pursued.7 Freddie Mac sends new foreclosures to its vendors on a monthly basis.

The vendors, in turn, request from Freddie Mac’s servicers and foreclosure attorneys
information that enables them to calculate whether any deficiency balances exist in the loan
files they receive. Next, the vendors evaluate the files, excluding those that they are

5
  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 (known as a third-party sale). If there is no potential buyer, the enterprise
takes possession of the property.
6
  Before June 1, 2013, Freddie Mac’s servicing guide required preservation of deficiency rights in 17 states
plus the District of Columbia. Preservation of deficiency rights requires the foreclosure attorney to file the
legal documents (perfect its rights) in accordance with applicable state statutes where the foreclosure occurred,
which allows pursuit of the deficiency for a certain period of time. See the following report section that
discusses changes Freddie Mac made in 2013 to its criteria concerning inclusion of third-party sales and
preserving deficiency rights in all states.
7
  In January 2011, as Freddie Mac explored adding vendors to manage its deficiencies, it stopped sending the
foreclosure listing to the vendor that had managed Freddie Mac’s deficiencies since 1993. Freddie Mac sent the
foreclosures that occurred between January 2011 and March 2012 to its new vendors once the parties signed
the contracts in March 2012.




                                  OIG  AUD-2013-010  September 24, 2013                                             10
precluded from pursuing under state law. Each vendor then uses its own criteria to determine
whether the remaining borrowers are able to repay the deficiencies, because Freddie Mac
has not provided guidance in this regard. As a general matter, vendors consider borrower
attributes, such as death, employment status, and bankruptcy filings, as screening criteria.

Vendors may purchase the right to collect deficiencies from Freddie Mac, and then remit a
portion of the recovered amount to the enterprise in accordance with its contract. Freddie
Mac applies such recoveries towards its losses on the foreclosed properties.

According to Freddie Mac’s vendors, it may take months or even years to collect on a
deficiency.

    Evolution of Freddie Mac’s Deficiency Management Program

Freddie Mac’s deficiency management program has evolved over time. After 2008,
Freddie Mac focused on foreclosure prevention and loss mitigation, rather than pursuing
deficiencies, because of the financial crisis and housing market downturn. However,
the enterprise more recently has enhanced its recovery efforts by revising its vendor
relationships, improving guidance to servicers, and re-emphasizing deficiency management
processes.

Freddie Mac began its deficiency management program in 1993, with a single recovery
vendor. In 2010, Freddie Mac solicited other vendors to provide these services. In March
2012, Freddie Mac selected and signed agreements with two new vendors.8 During the
period January 2011 to March 2012, the enterprise did not send foreclosure sales to its
vendors for evaluation and pursuit of deficiencies. As a result, in the spring of 2012, the
vendors confronted a backlog of 39,655 foreclosures to evaluate for collectability. Their
task was made even more difficult by the lack of required documentation from servicers and
foreclosure attorneys. As a result, by the end of 2012, Freddie Mac’s newest vendors had yet
to calculate and confirm a deficiency for pursuit on any foreclosures referred by Freddie
Mac since signing their contracts in March 2012.

In addition to adding new vendors to pursue recoveries on deficiencies, Freddie Mac
recently modified its deficiency management guidance. Freddie Mac originally required its
servicers to preserve the right to pursue a deficiency in 17 states and the District of
Columbia.9 Consequently, Freddie Mac referred foreclosures only in those jurisdictions to
8
 Although Freddie Mac’s original vendor still evaluates and pursues the foreclosures it received from Freddie
Mac prior to January 2011, Freddie Mac sends foreclosure sales occurring since January 2011 to its two newer
vendors.
9
 The servicer had the option to preserve the right to pursue a deficiency in other states if it believed it was in
Freddie Mac’s best interest, but Freddie Mac had to approve the servicer’s written request in such instances.




                                  OIG  AUD-2013-010  September 24, 2013                                            11
its vendors for evaluation and pursuit. Based on recommendations from its vendors in
October 2012, Freddie Mac revised its guidance so that effective June 1, 2013, servicers
must preserve deficiency rights in all states where it (1) is legally allowed to pursue
deficiencies and (2) does not result in additional foreclosure-related losses for Freddie
Mac.10 Consistent with its new guidance, Freddie Mac said it has started referring new
foreclosures in all 50 states and the District of Columbia to its vendors for their evaluation
and pursuit.11 However, Freddie Mac has not referred to its vendors existing foreclosures
that occurred prior to June 2013 from these additional states.

Freddie Mac has also been working to change its deficiency management processes. For
example, the enterprise historically did not refer third-party sales, but referred foreclosures
to its vendors only when it acquired the property in the foreclosure sale. Beginning in
January 2013, Freddie Mac officials stated they started referring new third-party sales to
the enterprise’s vendors. However, Freddie Mac officials said that the enterprise had not
referred to its vendors deficiencies associated with third-party sales that occurred prior to
January 2013.

Similarly, although Freddie Mac received summary and detail spreadsheets from its vendors
regarding collections they pursued, the enterprise historically did not have the ability to
track the thousands of foreclosures it sent to its vendors. As a process improvement, Freddie
Mac stated that in January 2013 it implemented a new deficiency management database,
which will facilitate the tracking of the vendors’ progress on each foreclosure the vendors
evaluate.

Figure 2 depicts the key events in Freddie Mac’s deficiency management vendor
relationships.




10
   There are 16 states where the state laws extremely limit or otherwise prevent vendors from pursuing
deficiencies against borrowers, as well as scenarios in which the vendors have determined pursuit not to be
economically feasible. Therefore, there are 35 states, including the District of Columbia, where deficiencies
can be pursued by Freddie Mac. Until June 2013, Freddie Mac referred foreclosures in only 18 of those 35
states, including the District of Columbia, leaving 17 states where deficiencies could be pursued and were not.
11
   Freddie Mac stated that it started referring deficiencies in all states because it does not attempt to interpret
state or local law, so it instructs its servicers to preserve its rights where legally allowed through the traditional
foreclosure process.




                                   OIG  AUD-2013-010  September 24, 2013                                               12
        FIGURE 2: TIMELINE OF KEY EVENTS IN FREDDIE MAC’S DEFICIENCY MANAGEMENT
                                   VENDOR RELATIONSHIPS




Sources: Interviews with Freddie Mac management and information from the vendor contracts.

    Strategic Defaulters

Each of Freddie Mac’s three collection vendors has methodologies to identify potential
strategic defaulters when considering which deficiency balances to attempt to collect.
However, the vendors stated they do not apply their methodologies to Freddie Mac’s
potential deficiencies because Freddie Mac has not instructed them to target strategic
defaulters. In contrast, Fannie Mae specifically targets potential strategic defaulters in
an effort to recover from those borrowers with the ability to repay a deficiency.

Freddie Mac’s Evaluation of Its Vendors’ Performance

Freddie Mac evaluates its vendors’ performance through regular reporting and status
communications. On a monthly basis, Freddie Mac obtains summary and detail reports
from its vendors. Freddie Mac utilizes this information to compare the vendors’ performance
based on the number of foreclosures sent to them, gross collections, and the collection
amount remitted to Freddie Mac. In addition, Freddie Mac also obtains further detail about
each vendor’s collection efforts, including the number of uncollectible deficiencies, the
number of deficiencies that were closed due to full or partial settlements, and the number


                               OIG  AUD-2013-010  September 24, 2013                        13
of deficiencies in which borrowers were on a repayment plan. Beyond this reporting,
Freddie Mac and the vendors characterize their status communications as frequent.




                          OIG  AUD-2013-010  September 24, 2013                     14
FINDINGS .................................................................................

     1. Freddie Mac Did Not Refer Nearly 58,000 Foreclosures to Its Vendors to
        Evaluate Borrowers’ Ability to Repay

During the period January 2010 through June 2012, Freddie Mac experienced 220,000
foreclosures resulting in estimated deficiencies of $19.6 billion.12 Almost half of these
foreclosures, about 103,000 with estimated deficiencies of $11.3 billion, could not be
pursued due to state laws. Of the remaining 117,000 foreclosures, Freddie Mac did not refer
nearly 58,000—all in states that allow pursuit of deficiency judgments—to its vendors to
evaluate collectability.13 This occurred primarily because Freddie Mac employed inadequate
policies that did not maximize referrals to vendors or ensure prioritization, coordination, and
monitoring of deficiency collection activity among servicers, foreclosure attorneys, and
collection vendors. As a result, Freddie Mac’s vendors missed the opportunity to evaluate
the collectability of $4.6 billion in estimated deficiencies. Although only a fraction of these
deficiencies may have been recoverable, pursuing deficiencies could have mitigated some
credit losses and served as a deterrent to borrowers who may consider strategically
defaulting. Accordingly, during the course of OIG’s audit, Freddie Mac began to strengthen
the controls over its deficiency recovery practices, but neither FHFA nor Freddie Mac have
formally evaluated the efficiency and effectiveness of the enterprise’s overall recovery
strategies.

The 58,000 foreclosures that were not referred for evaluation and pursuit of deficiencies
included: (1) 43,742 foreclosure sales with $2.7 billion in estimated deficiencies in states
where Freddie Mac did not pursue deficiencies but one of its vendors had recovered
deficiencies on behalf of Fannie Mae; and (2) 14,160 foreclosure sales with $1.9 billion in
estimated deficiencies related to third-party sales.14



12
  The 220,000 foreclosures between January 2010 and the end of June 2012 are part of the total of 460,000
foreclosures that occurred between the start of Freddie Mac’s conservatorship in September 2008 and the end
of December 2012. Also, because Freddie Mac’s vendors had not calculated the deficiency balances for the
majority of the foreclosure sales during this audit’s scope period, OIG calculated estimated deficiency balances
for the audit based on Freddie Mac data detailing the unpaid principal balance at foreclosure sale, delinquent
interest, charge-offs, foreclosure sale bid amount, repurchase (if applicable), and mortgage insurance coverage
percent (if applicable). As this is an estimate, it could vary from the vendors’ official deficiency calculation.
13
  There were another approximately 7,000 foreclosure sales that Freddie Mac did not refer to its vendors that
occurred in states in which Freddie Mac’s largest collection vendor historically had negligible collections.
14
   The $1.9 billion in estimated deficiencies on 14,160 foreclosures represents only those third-party sales in
states where one of Freddie Mac’s vendors had recovered deficiencies on behalf of Fannie Mae.




                                 OIG  AUD-2013-010  September 24, 2013                                            15
Freddie Mac provided two reasons for not referring the 58,000 foreclosures to its vendors.15
First, under its then-current guidance, Freddie Mac’s vendors only pursued deficiencies in
17 states and the District of Columbia. Although the servicers could recommend that
Freddie Mac permit them to preserve the enterprise’s rights in other states, Freddie Mac
stated it had not received such requests during the period January 2010 through June 2012.
Consequently, it could not refer deficiencies occurring in the additional jurisdictions to its
vendors.16 Second, Freddie Mac explained that its third-party sales exclusion was an
internal, informal practice that resulted from a mistake by Freddie Mac staff.

Pursuing deficiencies in additional states where it is lawful to do so and on third-party
foreclosure sales—practices its competitor, Fannie Mae, follows—can result in additional
recoveries for Freddie Mac and provide an appropriate deterrent to strategic defaulters.
And, indeed, during the OIG audit Freddie Mac took action to require servicers to preserve
deficiency rights for pending foreclosures in all 50 states plus the District of Columbia and
began referring third-party sales to its vendors.

Moreover, although Freddie Mac has monitoring controls in place for its vendors, it has
not implemented overall oversight of its deficiency recovery activities across its servicers,
foreclosure attorneys, and collection vendors. As discussed in Finding 2 below, coordination
among Freddie Mac’s foreclosure and deficiency collection counterparties is key to ensuring
the enterprise’s deficiency management program achieves intended results.

FHFA can increase its assurance that Freddie Mac is consistently and prudently pursuing
deficiencies by requiring the enterprise to pursue deficiencies from borrowers with the
ability to repay, where allowed by state law and regardless of the foreclosure sale type
(i.e., real estate owned and third-party sales). Additionally, FHFA should periodically
assess the enterprise’s recovery strategies and monitoring controls within its deficiency
management program. Freddie Mac may expose itself to reputational risk by allowing
borrowers with the ability to repay—for example, investors owing amounts on non-owner
occupied properties—to avoid repayment of deficiencies. Further, Freddie Mac may
encourage strategic default if it does not pursue deficiencies from those borrowers who
possess the ability to repay.




15
  Freddie Mac also stated that its recoveries were likely impacted to some extent by its decision to suspend
referral of 39,655 foreclosures during the period January 2011 to March 2012, while it was in the process of
selecting additional collection vendors.
16
     See footnote 10.




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     2. Delays in the Vendors’ Evaluation Process Limited Their Opportunity to Pursue
        Borrowers Who Can Repay

Of the 52,000 foreclosures referred for collection, Freddie Mac’s vendors were unable to
evaluate approximately 6,000 foreclosures (with estimated unpaid principal balances of
$1.4 billion) because they could not timely obtain foreclosure-related documentation from
other Freddie Mac counterparties, such as servicers and foreclosure attorneys.17 These
delays precluded the vendors from (1) identifying and estimating potential deficiency
amounts and (2) initiating deficiency collection activities in states that have statutes of
limitations of a year or less.

Proper internal control helps mitigate risks. The Committee of Sponsoring Organizations of
the Treadway Commission (COSO) established an internal control framework that is widely
used by publicly traded corporations, such as Freddie Mac. This framework applies to
deficiency recoveries because collections are revenue that offset recorded losses and impact
financial reporting.

Monitoring is one of five control standards within the control framework. COSO requires
that management monitor internal controls, whether through ongoing monitoring activities,
separate evaluations, or a combination of the two.

Among Freddie Mac’s controls, it contractually requires its vendors to complete their
evaluation of referred foreclosure sales within 5 to 15 days of receipt of data from the
enterprise. However, according to Freddie Mac, this contract requirement was seldom
enforced due to extended delays in obtaining the necessary documents from servicers and
foreclosure attorneys. For example, Freddie Mac sent to one vendor over 8,000 foreclosure
sales for evaluation during 2012. Of that number, foreclosure documentation was obtained
for only 400 sales as of December 31, 2012, and that documentation took more than six
months to receive from the date the foreclosure sales were referred. As to the remaining
7,600 foreclosure sales that were referred, the vendor was still awaiting information as of the
end of OIG’s audit fieldwork, and thus it could not evaluate these deficiencies for collection
let alone initiate collection activities.


17
  In order to estimate the unpaid principal balance for the 6,000 foreclosures, OIG utilized Freddie Mac’s
average original unpaid principal balance as reported in its May 2013 “Single Family Loan Summary
Statistics” for the years 2010 and 2011, and multiplied it by the number of liquidated mortgages whose statute
of limitations expired as of December 31, 2012. Data for 2012 were not available in the referenced Freddie
Mac report.
OIG also observes that the number of foreclosed mortgages not pursued or closed because of document delays
is likely greater than 6,000. Only one of Freddie Mac’s vendors assigns a code to foreclosures for which it
cannot calculate a deficiency because of a lack of documents. The other vendors do not collect such data.




                                OIG  AUD-2013-010  September 24, 2013                                          17
The most recent third-party review conducted at Freddie Mac’s largest collection vendor
also identified documentation delays as a problem. The resulting report stated that there
were 12,465 potential deficiencies that the vendor could not completely evaluate because it
was awaiting documents for the subject foreclosures. OIG confirmed with each of Freddie
Mac’s three vendors that timely receipt of documentation remains a key issue.

Although Freddie Mac is aware of the delays, the enterprise had not specified a timeframe
for counterparties to provide foreclosure-related documents to its vendors. Nor has Freddie
Mac implemented monitoring controls to prioritize deficiency collection activities (including
delivery of required foreclosure-related documents) in states with brief statutes of
limitations. Similarly, FHFA has not directed Freddie Mac to establish such controls. As
such, the enterprise’s vendors may expend significant time and effort trying to obtain the
documentation.

Additionally, according to Freddie Mac officials, servicers and foreclosure attorneys have
not faced financial or other consequences for not sending documents to the vendors. Rather
than impose financial penalties, Freddie Mac officials stated that they have preferred to
work with the counterparties to get the necessary documents to its vendors faster. For
example, the enterprise has provided the vendors with a template letter to assist them in
obtaining the documents from the servicers and foreclosure attorneys in a more timely
fashion. The template authorizes and directs the servicers and foreclosure attorneys to share
the requested deficiency-related information with the vendors. Nonetheless, according to the
vendors, the template has not had an appreciable effect on reducing delays in receipt of
required documentation.




                           OIG  AUD-2013-010  September 24, 2013                              18
CONCLUSIONS ..........................................................................

As conservator of Freddie Mac, FHFA is responsible for ensuring the enterprise conserves
and preserves its assets. Pursuing deficiency recoveries from those with the ability to repay
may help reduce Freddie Mac’s foreclosure-related losses. In addition, it could serve as a
deterrent to borrowers who may consider strategically defaulting on their mortgages, despite
having the ability to pay their contractual obligations. However, Freddie Mac did not have
sufficient controls in place to achieve these objectives.




RECOMMENDATIONS ...............................................................

OIG recommends that FHFA:

   1. Evaluate periodically the efficiency and effectiveness of Freddie Mac’s deficiency
      recovery strategies for the pursuit of borrowers with the ability to repay.

   2. Review Freddie Mac’s monitoring controls over its servicers, foreclosure attorneys,
      and collection vendors involved in deficiency recovery activities to ensure that
      oversight across these counterparties is maintained.

   3. Direct Freddie Mac to enforce controls for its counterparties to deliver timely
      documents to deficiency recovery vendors necessary to calculate and pursue
      deficiencies, and provide for financial consequences for counterparties that fail to
      meet delivery deadlines.

   4. Direct Freddie Mac to implement a control to consider timeframes in state statutes of
      limitations when prioritizing, coordinating, and monitoring deficiency collection
      activity for borrowers with the ability to repay.




                           OIG  AUD-2013-010  September 24, 2013                              19
OBJECTIVE, SCOPE, AND METHODOLOGY .................................

The objective of this performance audit was to assess FHFA’s oversight of the effectiveness
of Freddie Mac’s deficiency recovery processes for borrowers who possess the ability to
repay deficiencies. The scope of the audit was January 2010 through June 2012 and was
expanded as necessary to obtain more current data for reporting purposes.

OIG performed fieldwork for this audit from September 2012 through May 2013. OIG
conducted fieldwork at FHFA’s office in Washington, D.C., and Freddie Mac’s office in
McLean, Virginia.

To achieve this audit objective, OIG:

      Researched the performance metrics and best practices used by the deficiency
       recovery industry, Freddie Mac, and its deficiency vendors to evaluate their
       respective deficiency recovery processes;
      Reviewed Freddie Mac deficiency recovery processes, procedures, servicing guides,
       and related documents;
      Reviewed vendor deficiency management policies, procedures, reports, and related
       documents;
      Interviewed Freddie Mac officials and personnel from all of Freddie Mac’s
       deficiency collection vendors concerning their deficiency recovery policies and
       procedures;
      Reviewed the compliance audit review conducted by a third-party firm on behalf of
       Freddie Mac; and
      Analyzed foreclosure sale data and active loans related to the enterprises from
       January 1, 2010, through June 30, 2012.

OIG assessed the reliability of data received for this audit, as deemed necessary, by
corroborating the information with publicly available reports and other source data.

OIG also assessed the internal controls related to the audit objective. Based on the work
completed on this performance audit, OIG considers weaknesses in FHFA’s supervisory
oversight of Freddie Mac’s controls over its deficiency recovery processes to be significant
in the context of the audit’s objective. Additionally, other less significant matters that came
to OIG’s attention during the audit will be communicated separately to FHFA in an audit
memorandum.




                            OIG  AUD-2013-010  September 24, 2013                               20
OIG conducted this performance audit in accordance with Generally Accepted Government
Auditing Standards. Those standards require that OIG plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for the audit findings and
conclusions based on the audit objective. OIG believes that the evidence obtained provides a
reasonable basis for the findings and conclusions included herein, based on the audit
objective.




                           OIG  AUD-2013-010  September 24, 2013                             21
APPENDIX A .............................................................................

FHFA’s Comments on OIG’s Findings and Recommendations




                        OIG  AUD-2013-010  September 24, 2013                        22
OIG  AUD-2013-010  September 24, 2013   23
APPENDIX B..............................................................................

OIG’s Response to FHFA’s Comments

On September 4, 2013, FHFA provided comments to a draft of this report, agreeing with the
recommendations and identifying FHFA actions to address them. Importantly, FHFA issued
an Advisory Bulletin on September 16, 2013, regarding deficiency balances including
requirements for both enterprises to (a) maintain formal policies and procedures for
managing their deficiency collection processes for borrowers who strategically default on
their mortgage obligations, (b) establish controls to monitor the activities of all
counterparties involved in deficiency balance management to ensure that deficiency balance
management processes are timely, effective, and efficient, and (c) comply with the
applicable state statutes of limitations in order to preserve the ability to pursue collection of
deficiencies.

FHFA also agreed that, by January 31, 2014, the Division of Enterprise Regulation will
develop and implement ongoing monitoring procedures to assess the effectiveness of the
enterprises’ deficiency judgment process on a periodic basis, including (a) evaluation of
efficient and effective deficiency recovery strategies, (b) enterprise monitoring controls over
its servicers, foreclosure attorneys, and collection vendors, and (c) assessment of
implementation by the enterprises of the Advisory Bulletin provisions relating to timely
document handling and other provisions. OIG considers FHFA’s planned actions to be
sufficient to resolve the recommendations, which will remain open until OIG determines
that the agreed-upon corrective actions are completed and responsive to the
recommendations. OIG considered the agency’s full response (attached as Appendix A),
along with technical comments, in finalizing this report. Appendix C provides a summary of
management’s comments on the recommendations and the status of agreed-upon corrective
actions.

OIG has also issued a related report on FHFA’s oversight of Fannie Mae’s deficiency
recoveries.




                            OIG  AUD-2013-010  September 24, 2013                                 24
APPENDIX C ..............................................................................

Status of Agreed-Upon Corrective Actions

This table presents the management response to the recommendations in OIG’s report and
the status of the recommendations as of when the report was issued.

                                                   Expected
Rec.             Corrective Action:               Completion   Monetary   Resolveda   Open or
No.              Taken or Planned                    Date      Benefits   Yes or No   Closedb
       FHFA will issue an Advisory Bulletin on
       deficiency balances that will require
       the enterprises to maintain formal
       policies and procedures for managing
       deficiency collection processes for
 1                                                1/31/2014       $0        Yes        Open
       strategic defaulters. In addition, FHFA
       will perform ongoing monitoring to
       assess the effectiveness of the
       enterprises’ deficiency judgment
       processes.
       FHFA will perform ongoing monitoring
       to assess the effectiveness of the
       enterprises’ monitoring controls over
       its servicers, foreclosure attorneys,
 2                                                1/31/2014       $0        Yes        Open
       and collection vendors, as well as the
       possible use of indemnification for
       counterparties’ failure to recover
       adequately on deficiency balances.
       FHFA will issue an Advisory Bulletin on
       deficiency balances that will require
       the enterprises to establish controls
       to monitor the timeliness,
       effectiveness, and efficiency of
 3     counterparties involved in managing        1/31/2014       $0        Yes        Open
       their deficiencies. In addition, FHFA
       will assess how the enterprises have
       implemented the Advisory Bulletin
       provisions, including those related to
       timely document handling.
       FHFA will issue an Advisory Bulletin on
 4     deficiency balances that will require      1/31/2014       $0        Yes        Open
       the enterprises to comply with
       applicable state statutes of limitations


                             OIG  AUD-2013-010  September 24, 2013                            25
                                                     Expected
Rec.               Corrective Action:               Completion       Monetary       Resolveda        Open or
No.                Taken or Planned                    Date          Benefits       Yes or No        Closedb
        to preserve the ability to pursue
        collections. In addition, FHFA will
        perform ongoing monitoring to assess
        the effectiveness of the enterprises’
        deficiency judgment processes.


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 OIG monetary benefits, a different amount, or no amount ($0). Monetary benefits are considered resolved
as long as management provides an amount.
b
  Once OIG determines that the agreed-upon corrective actions have been completed and are responsive, the
recommendations can be closed.




                                OIG  AUD-2013-010  September 24, 2013                                        26
ADDITIONAL INFORMATION AND COPIES .................................


For additional copies of this report:

      Call: 202-730-0880
      Fax: 202-318-0239
      Visit: 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: 1-800-793-7724
      Fax: 202-318-0358
      Visit: www.fhfaoig.gov/ReportFraud
      Write:
                   FHFA Office of Inspector General
                   Attn: Office of Investigation – Hotline
                   400 Seventh Street, S.W.
                   Washington, DC 20024




                            OIG  AUD-2013-010  September 24, 2013                      27