oversight

Additional FHFA Oversight Can Improve the Real Estate Owned Pilot Program

Published by the Federal Housing Finance Agency, Office of Inspector General on 2013-09-27.

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

          Federal Housing Finance Agency
              Office of Inspector General




Additional FHFA Oversight Can
          Improve the
Real Estate Owned Pilot Program




Audit Report  AUD-2013-012  September 27, 2013
                Additional FHFA Oversight Can Improve the Real Estate
                Owned Pilot Program
                Why OIG Did This Audit
                The Federal Housing Finance Agency (FHFA or agency) currently serves as
                both regulator and conservator of the Federal National Mortgage Association
                (Fannie Mae or enterprise) and the Federal Home Loan Mortgage Corporation
Synopsis        (Freddie Mac) (collectively, the enterprises), with a responsibility to preserve
                and conserve their assets. The enterprises support the nation’s housing finance
   ———          system by acquiring mortgages in the secondary mortgage market, which gives
                lenders the liquidity to make additional loans. The enterprises can either retain
September 27,   mortgages they purchase or securitize them by pooling them into mortgage-
    2013        backed securities (MBS) that are then sold to investors. Typically, when
                borrowers default on these mortgages and efforts to cure the defaults are
                unsuccessful, the mortgages are foreclosed on. Through foreclosure, properties
                that secure the defaulted mortgages can be acquired by the enterprises as real
                estate owned (REO) properties.
                The enterprises’ REO inventory levels increased dramatically in the years
                following the financial crisis. In accordance with its broad conservatorship
                objective to minimize costs and maximize net present value of REO, FHFA
                initiated a pilot program in 2012 to assist with REO disposition efforts. The
                REO Pilot Program was the first, and to date only, transaction to be conducted
                under a broader FHFA initiative to develop and implement an improved REO
                disposition program. For the pilot transaction, about 2,500 single-family
                Fannie Mae REO properties, many with tenants, were consolidated into pools
                in eight geographic areas and offered to prequalified investors for sale.
                The objective of this performance audit was to assess FHFA’s oversight of
                Fannie Mae’s policies, procedures, and practices with respect to the selection
                and administration of investors participating in the REO Pilot Program.

                What OIG Found
                FHFA established a sound process for reviewing, scoring, and recommending
                investors to qualify as bidders under the REO Pilot Program. However, Fannie
                Mae’s bidder qualification contractor did not fully comply with important
                provisions of the established process. Specifically, the contractor did not
                properly score the risk attributes for 12 of 47 potential investors, 6 of whom
                were determined to be eligible to bid even though they did not meet prescribed
                bidder qualification scoring criteria. Moreover, certain areas of the application
                and scoring criteria require clarification if used for similar programs in the
                future.
                Additionally, Fannie Mae did not always follow its contractor’s scores and
                recommendations. For example, the enterprise, with FHFA’s concurrence,
                permitted two potential investors to bid on mortgage pools even though both
                were scored by the contractor as high risk and not recommended to bid.
                Further, FHFA did not independently verify the work performed by Fannie
                Mae’s bidder qualification contractor, and, thus, the instances of
                noncompliance were not discovered by the agency.
                In addition, FHFA has not clarified several goals that are applicable to the
                REO Pilot Program. Specifically, FHFA has not clarified how the goals and
                objectives of the pilot program will be achieved, or how the agency intends to
                monitor and assess the performance of the pilot or any other future initiatives
Synopsis        under the overall REO disposition program. In particular, FHFA has not
   ———          prepared a program plan to guide its REO disposition-related initiatives. Such
                planning is important to provide the oversight needed to ensure proper
September 27,   disposition of Fannie Mae’s extensive REO inventory.
    2013
                What OIG Recommends
                FHFA should: (1) establish verification controls to ensure enterprise
                contractors are performing in accordance with agreed criteria and that any
                proposed waivers to the criteria are documented and submitted for FHFA
                review and approval; (2) clarify guidance regarding bidder submission of
                financial statements and explanation of adverse financial events as part of the
                bidder qualification process; and (3) issue formal guidance for the REO
                disposition program, including the REO Pilot Program, requiring a program
                plan with clearly defined goals and objectives, a program monitoring and
                oversight mechanism, criteria to measure and evaluate program success, and
                the means to assess alternative REO disposition strategies.
                FHFA generally agreed with OIG’s recommendations and will implement
                corrective action if transactions beyond the initial REO Pilot Program are
                pursued.
TABLE OF CONTENTS ................................................................

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

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

CONTEXT .......................................................................................................................................8
      REO ..........................................................................................................................................8
      FHFA’s REO Initiative .............................................................................................................8
      First Transaction of the REO Initiative: the REO Pilot Program ...........................................10
      Bidder Qualification Process for the REO Pilot Program ......................................................11
              Potential Bidder Experience ...........................................................................................12
              Transaction Type’s Impact on the Qualification Process ...............................................12
      Winning Bidders .....................................................................................................................13
      LLC Structure .........................................................................................................................14

FINDINGS .....................................................................................................................................16
      1. The Process for Reviewing, Scoring, and Recommending Investors for the REO
      Pilot Program Was Not as Rigorous as Intended....................................................................16
              Bidder Application Scoring Process ...............................................................................16
              Prescribed Risk Scoring Process Not Followed in Some Cases .....................................16
              FHFA Did Not Independently Verify Applications or Scoring ......................................18
              Inconsistent Scoring Increases Risks ..............................................................................19
              Two Unqualified Investors Subsequently Determined Eligible to Bid ..........................19
              Impact of Noncompliance with Bidder Criteria .............................................................20
              Scoring Process for Qualifying Pilot Program Investors Could Affect Future
                  REO Disposition Initiatives.....................................................................................20
              Summary .........................................................................................................................21
      2. FHFA’s Goals and Objectives for Overseeing the REO Disposition Program,
      Including the REO Pilot, Can Be Strengthened and Improved ..............................................21
              Goals and Objectives for REO Disposition Have Evolved ............................................21
              Need for an REO Disposition Program Plan ..................................................................22



                                         OIG  AUD-2013-012  September 27, 2013                                                                   4
             REO Disposition Will Remain an FHFA Priority ..........................................................24
             FHFA Previously Recommended Fannie Mae Establish a Governing Process for
                Pilot Programs .........................................................................................................24
             Oversight and Monitoring of Pilot Program ...................................................................25
             Summary .........................................................................................................................25

CONCLUSIONS............................................................................................................................27

RECOMMENDATIONS ...............................................................................................................27

OBJECTIVE, SCOPE, AND METHODOLOGY .........................................................................28

APPENDIX A ................................................................................................................................30
      FHFA’s Comments on OIG’s Findings and Recommendations ............................................30

APPENDIX B ................................................................................................................................33
      OIG’s Response to FHFA’s Comments .................................................................................33

APPENDIX C ................................................................................................................................35
      Summary of FHFA’s Comments on the Recommendations ..................................................35

APPENDIX D ................................................................................................................................36
      2012 YTD REO Inventory Inflow and Outflow .....................................................................36

APPENDIX E ................................................................................................................................37
      REO Pilot Program Timeline of Events .................................................................................37

ADDITIONAL INFORMATION AND COPIES .........................................................................38




                                       OIG  AUD-2013-012  September 27, 2013                                                                5
ABBREVIATIONS .......................................................................

Fannie Mae or enterprise     Federal National Mortgage Association

FDIC                         Federal Deposit Insurance Corporation

FHFA or agency               Federal Housing Finance Agency

Freddie Mac                  Federal Home Loan Mortgage Corporation

HUD                          Department of Housing and Urban Development

IAWG                         Interagency Working Group

LLC                          Limited Liability Company

MBS                          Mortgage-Backed Securities

OIG                          Federal Housing Finance Agency Office of Inspector General

REIT                         Real Estate Investment Trust

REO                          Real Estate Owned

RFI                          Request for Information

Treasury                     U.S. Department of the Treasury




                           OIG  AUD-2013-012  September 27, 2013                        6
PREFACE ...................................................................................

The Housing and Economic Recovery Act of 2008 established the FHFA Office of Inspector
General (OIG). OIG is authorized to conduct audits, evaluations, investigations, and other law
enforcement activities pertaining to FHFA’s programs and operations. As a result of OIG’s
work, OIG may recommend policies that promote economy and efficiency in administering
FHFA’s programs and operations, or that prevent and detect fraud and abuse in them.

Given the risks associated with the enterprises’ REO management, this audit report is part of
OIG’s proactive audit and evaluation strategy to assess the agency’s related oversight and
conservatorship efforts. One aspect of this strategy focuses on REO to determine whether the
agency and the enterprises manage REO to maximize financial recoveries and minimize
foreclosures’ negative effects on communities.

This report furthers OIG’s REO work by assessing the process and controls governing
FHFA’s and Fannie Mae’s implementation and monitoring of the REO Pilot Program. OIG
found that the process for reviewing, scoring, and recommending selection of investors for
participation in the REO Pilot Program was not as rigorous as intended. Additionally, FHFA’s
oversight of the program can be improved. This report’s recommendations (along with those
in prior reports) can increase FHFA’s assurance that the enterprises are operating safely and
soundly, and that their assets are being preserved and conserved.

OIG appreciates the cooperation of everyone who contributed to this audit, including officials
at Fannie Mae and FHFA. This audit was led by Kevin Carson, Audit Director, who was
assisted by Damon Jackson, Auditor-in-Charge, and Rachael Young, Auditor.

This audit 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-2013-012  September 27, 2013                               7
CONTEXT ..................................................................................

REO

FHFA currently serves as both regulator and conservator of the enterprises. As regulator, the
agency’s mission is to ensure that the enterprises operate in a safe and sound manner. As
conservator, the agency seeks to conserve and preserve enterprise assets.

The enterprises support the nation’s housing finance system by buying and selling mortgages
in the secondary mortgage market. The enterprises either retain or securitize the mortgages
they purchase by pooling them into MBS, which are then sold to investors. Typically, when
borrowers default on these mortgages and efforts to cure the defaults are unsuccessful, the
mortgages are foreclosed on. Through foreclosure, properties that secure the defaulted
mortgages are acquired by the enterprises as REO.

The enterprises suffer losses when inadequately collateralized mortgages go into default and
the enterprises either own the loans or guarantee them as part of an MBS transaction.
Inadequate collateral means that the value of the property securing a mortgage is less than the
unpaid principal balance of the mortgage. This can occur as a result of, among other factors,
significant market declines or poor underwriting of the loan.

The enterprises attempt to minimize these losses by taking ownership (through foreclosure
and other means) of the properties securing the defaulted mortgages, and then marketing and
selling them through local real estate professionals. The primary objectives in selling
foreclosed properties are to (1) minimize the severity of loss by maximizing sales prices and
(2) stabilize neighborhoods by preventing unoccupied homes from depressing home values in
surrounding areas. Other disposition methods used by the enterprises include selling homes to
cities, municipalities, and other public entities, and selling properties in bulk or through public
auctions. Appendix D provides a breakdown of methods used by Fannie Mae for REO
disposition.

FHFA’s REO Initiative

The enterprises’ REO inventory levels increased dramatically in the years following the
financial crisis, and they have remained at elevated levels. Figure 1 provides details regarding
Fannie Mae’s REO inventory levels from 2007 through 2012, when the REO Pilot Program
began.




                            OIG  AUD-2013-012  September 27, 2013                                   8
In accordance with its broad               FIGURE 1. FANNIE MAE END OF YEAR REO INVENTORY
conservatorship objective to                                   2007–20121
preserve and conserve
                                   180,000
enterprise assets, including                                                   162,489
through minimizing costs and       160,000
maximizing net present value       140,000
of REO, FHFA initiated a           120,000
                                                                                        118,528
program to assist with REO
                                   100,000                                                  105,666
disposition efforts. In August
                                     80,000                           86,155
2011, FHFA, in consultation
with the Department of the           60,000                   63,538
Treasury (Treasury) and the          40,000
                                                    33,729
Department of Housing and
                                     20,000
Urban Development (HUD),
                                          0
launched the REO Initiative
                                               2007      2008     2009      2010    2011     2012
by issuing a request for
information (RFI) designed to solicit public input on options for selling single-family REO
properties held by Fannie Mae, Freddie Mac, and the Federal Housing Administration. In
addition to helping with the current and future disposition of REO, the purposes of the RFI
were to solicit ideas to improve loss recoveries compared to individual retail REO sales, help
stabilize neighborhoods and local home values, and expand the supply of rental housing
where feasible and appropriate.1

Consistent with these purposes, the RFI solicited ideas for the pooling for sale or rent of
single-family REO properties in specified geographic areas in a way that would maximize
their economic value. The RFI also sought to gather information about whether a third-party,
joint venture, or some other structure would be more effective at addressing local economic
and real estate conditions and managing REO than individual sales overseen by Fannie Mae
and Freddie Mac.

In response to the RFI, FHFA received more than 4,000 comments from a variety of
market participants, stakeholders, community groups, and industry observers with specific
suggestions for improving market conditions in the disposition of REO properties. The
respondents offered a range of transaction principles, guidelines, structures, and strategies.
Some respondents supported many of the asset disposition strategies and structures used by
the Federal Deposit Insurance Corporation (FDIC) for failed savings institutions, including

1
  Sources: Fannie Mae 2012 Annual Report (10-K), available at
http://www.fanniemae.com/resources/file/ir/pdf/quarterly-annual-results/2012/10k_2012.pdf; and Fannie Mae
2009 Annual Report (10-K), available at http://www.fanniemae.com/resources/file/ir/pdf/proxy-
statements/form10k_022610.pdf.



                               OIG  AUD-2013-012  September 27, 2013                                      9
joint venture partnerships, outright sales, and auctions. Other respondents recommended that
FHFA adopt approaches similar to Treasury’s Public-Private Investment Partnership program,
and still others proposed the use of real estate investment trust (REIT) structures. Most
respondents suggested disposition strategies that involved renting properties for a period of
time.

After the comment period closed, FHFA convened an Interagency Working Group (IAWG) to
help design the REO Initiative. The IAWG was comprised of representatives from federal
agencies with significant interests in the state of the housing market—FHFA, HUD, FDIC,
the Federal Reserve, and Treasury—and the enterprises. The IAWG met regularly to develop
a broad strategy based on ideas submitted through the RFI process and continuing research.

Based in part on the foregoing processes, FHFA issued a press release on February 1, 2012,
announcing the first, and to date only, program under the REO Initiative. This pilot program
would allow interested investors to prequalify to bid on transactions in an initial pilot phase as
well as subsequent phases. The initial pilot would allow qualified investors to purchase pools
of foreclosed properties from Fannie Mae—conditioned on the requirement that the investors
offer the properties purchased for rent for a specified number of years. FHFA stated that
interested investors could begin to prequalify for the transaction by demonstrating their
financial capability and operational expertise to manage properties in communities hit hard by
the housing downturn.

First Transaction of the REO Initiative: the REO Pilot Program

On February 27, 2012, FHFA publicly announced the first pilot program under the REO
Initiative. The pilot targeted several of the hardest-hit metropolitan areas. On this same date,
the FHFA acting director (with Treasury approval) 2 authorized the president and chief
executive officer of Fannie Mae to execute the REO Pilot Program, which was publicly
described as the REO-to-Rental Pilot Program.3

As part of the initial REO Pilot Program, a prequalified bidder would make a $250,000
deposit, sign a confidentiality agreement, and could then gain access to confidential Fannie
Mae data regarding the transaction and available properties. As part of the program,
approximately 2,500 single-family Fannie Mae REO properties configured in eight
geographic pools were offered for sale. Most of the properties had tenants in residence and
were located in areas that were greatly affected by the housing downturn, exhibited a strong

2
 Treasury approval is required for a transfer of assets in accordance with Section 5.4 of the Senior Preferred
Stock Purchase Agreement between Fannie Mae and Treasury.
3
 OIG refers to the REO-to-Rental Pilot Program as the REO Pilot Program throughout the report. The pilot
program was the first transaction in FHFA’s initiative to develop and implement an improved REO disposition
program at Fannie Mae.



                                 OIG  AUD-2013-012  September 27, 2013                                         10
demand for rental housing, and contained a significant number of Fannie Mae REO
properties. Figure 2 contains details by each geographic area regarding the number and type
of REO properties contained in each of the eight pools.

               FIGURE 2. REO INITIATIVE, PROPERTY DATA FOR FIRST PILOT TRANSACTION4




Bidder Qualification Process for the REO Pilot Program

To determine bidder eligibility, Fannie Mae primarily used the FDIC’s model for structured
sales of assets; in addition, it engaged an experienced contractor to oversee the bidder
qualification and evaluation process. The contractor developed a process for qualifying
potential bidders that encompassed establishing minimum qualifications for entities interested
in acting as investors, asset managers, or property management infrastructure firms. The
bidder qualification process was designed to be rigorous and included significant information
and documentation requirements for each of the applicants and their business partners. The
process was purposely designed to allow only investors with sufficient capital and operational
expertise to participate in a transaction.


4
 Source: Fannie Mae SFR REO 2012-1 Transaction Portfolio, available at http://homepath-activedt.netdna-
ssl.com/content/pdf/FNMASFRREO2012-1SummaryofAssets.pdf.



                               OIG  AUD-2013-012  September 27, 2013                                    11
   Potential Bidder Experience

Fannie Mae required all entities interested in qualifying as bidders to complete and submit
a bidder qualification application along with associated supporting documentation. The
applications were reviewed and scored by Fannie Mae’s bidder qualification contractor
based on scoring criteria developed by the IAWG (e.g., FHFA, FDIC, and Fannie Mae) and
the contractor. The scoring criteria were divided into five major sections covering the
potential bidder’s (1) financial background, (2) funding, (3) asset management, (4) property
management infrastructure, and (5) portfolio management plan. The scoring criteria contained
specific review components for each of these five sections:

      Financial background (e.g., credit rating, continuing net loss, going concern issues, or
       experience in real estate and mortgage finance)
      Funding (e.g., third-party support or reasonable timeframe to secure funding)
      Asset management (e.g., experience in managing real estate rental units)
      Property management infrastructure (e.g., staffing, adequate systems, or planning)
      Portfolio management (e.g., management, marketing, disposition strategies, or
       community relations activities)

Sections were scored either satisfactory or unsatisfactory. Depending on the number of
satisfactory scores, the investor was given a rating of low, medium, or high risk. With some
exceptions, if all five sections were satisfactory, the investor was rated low risk; if one of the
five sections was rated unsatisfactory, the investor was rated medium risk; and if two or more
sections were unsatisfactory, the investor was rated high risk.

Additionally, the IAWG emphasized a potential bidder’s relations with the community as part
of the bidder qualification scoring process. Community relations were evaluated in three of
the five sections of the application. If community relations were determined to be
unsatisfactory in the portfolio management section and either the asset management or
property management sections, then the bidder was scored high risk and not recommended to
bid.

   Transaction Type’s Impact on the Qualification Process

Potential bidders also were qualified depending on the type of bid they wanted to submit,
either sole ownership or joint venture transaction, and according to the desired geographic
pools of the REO properties.

Under a sole ownership transaction, a winning bidder would own 100% of the economic
interest in the assets. In contrast, under a joint venture transaction, the winning bidder would


                            OIG  AUD-2013-012  September 27, 2013                                  12
be the managing member of a joint venture with Fannie Mae. The respective ownership
interests would depend on the type of joint venture. For example, in a pro-rata joint venture,
the winning bidder would be entitled to 50% of the distributions to the equity holders for the
life of the joint venture. However, in a modified cash flow joint venture, the winning bidder
would be entitled to receive 10% of the distributions to the equity holders until the occurrence
of either the:

        Initial shift threshold event,5 after which the managing member interest would be
         entitled to receive 50% of the distributions to equity, or
        Secondary shift (return) threshold event,6 after which the managing member interest
         would be entitled to receive 30% of the distributions to equity.

A total of 73 potential bidders submitted applications to be considered as qualified bidders for
the REO Pilot Program. In May 2012, of the 73 applications submitted, 42 bidders were
determined qualified to bid on the pilot transaction by the bidder qualification contractor and
Fannie Mae, with FHFA approval.

Winning Bidders

On June 25, 2012, 6 of the 42 qualified bidders submitted best and final offers for REO pools.
Of the six, three bidders (i.e., Pacifica Companies LLC, Cogsville Group LLC, and Colony
Capital LLC) were awarded a total of seven of the eight pools. Fannie Mae and FHFA
decided not to award the eighth pool, which was comprised of 541 properties in Atlanta,
because the bids received did not exceed the value Fannie Mae estimated that it could achieve
through its REO retail sales channel. As a result, plans were made for the Atlanta properties to
be sold through either Fannie Mae’s retail process or through future structured sale
transactions. Figure 3 below provides further details on the winning bidders, the pools of
properties acquired, and the dollar value of each transaction.




5
 Initial shift threshold event: the amount paid by the managing member to acquire its interest in the newly
created limited liability company (LLC), multiplied by four.
6
  Secondary shift (return) threshold event: if certain yield and cash flow thresholds are achieved by the
managing member, then the equity interest from the LLC will shift again from 50% to 30% equity distributions
for the managing member.



                                 OIG  AUD-2013-012  September 27, 2013                                       13
                        FIGURE 3. WINNING BIDDERS OF THE REO PILOT PROGRAM7

                                                                             Recent
                                                Transaction                Third Party     Purchase      Transaction
                                    Winning       Closing       No. of        Value          Price          Value
          Geographic Pools          Investor       Date       Properties   ($ Millions)   ($ Millions)   ($ Millions)
    Atlanta, GA                                                This pool did not transact
    Chicago, IL                     Cogsville   9/27/2012        94           13.7            2.1           11.8
    Florida – Central & Northeast
    Florida – Southeast             Pacifica    9/6/2012         699          81.5           12.3           78.1
    Florida – West Coast
    Las Vegas, NV
    Los Angeles / Riverside, CA     Colony      11/1/2012        970         156.8           34.1          176.0
    Phoenix, AZ


Appendix E shows the timeline of events related to the REO Pilot Program from the release of
the RFI through the award and closing of the three transactions.

LLC Structure

Each of the three winning investors submitted bids utilizing the modified cash flow joint
venture structure, in which the investor proposed to partner with Fannie Mae and jointly enter
into a newly created limited liability company (LLC) in which the winning investor serves as
the managing member.

In effect, each winning investor purchased a managing member interest in the equity cash
flows of newly created LLCs, which would hold the properties transferred to the LLC by
Fannie Mae. Fannie Mae also retained interests in the equity cash flows of the LLCs. Each
investor, as managing member of the LLC, is responsible for managing the operations of the
LLC. Fannie Mae is initially entitled to receive 90% of the LLCs’ cash flows (and the
investors to receive 10%) until the shift thresholds are reached. Once a shift threshold is met,
Fannie Mae and the investor are each entitled to 50% of the cash flow. If the negotiated yield
and cash flow thresholds are met by the investor, the shift ratio subsequently changes to 70%
for Fannie Mae and 30% to the investor. Figure 4 further details the structure for the modified
cash flow joint ventures.


7
 Sources: FHFA News Release, September 10, 2012, “FHFA Announces First Winning Bidder in REO Pilot
Initiative,” available at http://www.fhfa.gov/webfiles/24273/REOInvestor91012.pdf; FHFA News Release,
October 2, 2012, “FHFA Announces Winning Investor in Chicago REO Pilot Initiative,” available at
http://www.fhfa.gov/webfiles/24561/REOInvestorsChicago100212.pdf; and FHFA News Release, November
1, 2012, “FHFA Statement on REO Pilot Transactions,” available at
http://www.fhfa.gov/webfiles/24609/REOColony.pdf.



                                OIG  AUD-2013-012  September 27, 2013                                       14
                    FIGURE 4. MODIFIED CASH FLOW JOINT VENTURE STRUCTURE8




8
 Source: OIG analysis based on Fannie Mae SFR REO 2012-1 Transaction Summary for Each Winning
Investor. See, http://homepath-activedt.netdna-ssl.com/content/pdf/structuredsales/SFR_2012-
1_Florida/SFR_2012-1_Florida_Transaction_Details_9-6-12.pdf; http://homepath-activedt.netdna-
ssl.com/content/pdf/structuredsales/SFR_2012-1_Chicago/SFR_2012-1_Chicago_Transaction_Summary_9-
27-12.pdf; and http://homepath-activedt.netdna-ssl.com/content/pdf/structuredsales/SFR_2012-
1_USWest/SFR_2012-1_US_West_Transaction_Summary_11-01-12.pdf.



                             OIG  AUD-2013-012  September 27, 2013                               15
FINDINGS .................................................................................

1. The Process for Reviewing, Scoring, and Recommending Investors for the
   REO Pilot Program Was Not as Rigorous as Intended

Overall, FHFA established a sound process for reviewing, scoring, and recommending
investors to qualify as bidders under the REO Pilot Program. However, Fannie Mae’s bidder
qualification contractor did not fully comply with important provisions of the established
process. Specifically, the contractor did not properly score risk for a number of investors,
some of whom were determined to be eligible to bid even though they did not meet prescribed
bidder qualification scoring criteria. In addition, two investors that had been scored by the
contractor as high risk and not recommended to bid based on the established process were
subsequently determined by Fannie Mae, with FHFA concurrence, to be eligible to bid.
Looking forward, FHFA oversight can be strengthened to ensure compliance with the
established process for future transactions, if any.

   Bidder Application Scoring Process

Seventy-three interested investors initially submitted applications to be considered as
qualified bidders. Under the established process, each investor’s application was reviewed and
scored by Fannie Mae’s bidder qualification contractor. Each application was scored either
satisfactory or unsatisfactory for each of the five major sections evaluated. Based on the
scoring for each section, the application was assigned an overall rating of low, medium, or
high risk. The bidder qualification contractor was supposed to recommend only those
investors rated as low or medium risk as qualified bidders. Once qualified, a bidder was then
able to submit bids on the various pools of REO properties to be offered under the pilot
program.

After the initial application submission, 13 of the original 73 interested investors withdrew
their applications and thus were not scored by the bidder qualification contractor. Of the
remaining 60 applications, 13 were determined to be incomplete and not scored. Of the
remaining 47 investor applications reviewed and scored, 9 bidders were rated low risk,
31 as medium risk, and 7 as high risk.

   Prescribed Risk Scoring Process Not Followed in Some Cases

Fannie Mae’s bidder qualification contractor incorrectly scored 12 of the 47 investor
applications. This improper scoring resulted in understated risk ratings for 7 of those
investors’ applications. Specific details concerning the 12 applications are as follows:




                            OIG  AUD-2013-012  September 27, 2013                              16
          Seven investors were assigned overall risk ratings that were understated based on the
           erroneous scoring performed by the bidder qualification contractor. Six of the seven
           investors were rated by the contractor as medium risk, but should have been rated high
           risk and thus not considered as qualified to submit bids. Two of these six investors—
           that should have been rated as high risk—actually submitted bids for the pilot program
           and were considered in the selection process, although they were not ultimately
           awarded any of the pools.
          Five additional investors were also scored incorrectly. However, the exceptions noted
           with the scoring did not affect their overall risk rating.
Figure 5 provides summary details regarding the results of OIG’s analysis of the scoring of
investor applications.

                                                                                         9
                      FIGURE 5. SCORING OF INVESTOR QUALIFICATION APPLICATIONS


   Bidder Score Given by             No. of         Correctly         Incorrectly
   Fannie Mae Contractor           Applications      Scored             Scored
Low                                      9              8                  1
Medium                                  31             23                  8
High                                     7              4                  3
Total Applications Scored               47             35                 12


                                               No. of Bidders with        No. of Bidders with
                                               Incorrect Score that       Incorrect Score that
                    Bidder Score Given by         Resulted in an             Resulted in a
                   Fannie Mae Contractor      Unchanged Risk Score        Changed Risk Score
                  Low                                    0                          1
                  Medium                                 2                          6
                  High                                  3                           0
                  Total Applications Scored             5                           7




                                                Bidder Score Given by          Resultant Risk Score
                                               Fannie Mae Contractor           Medium        High
                                              Low                                1             0
                                              Medium                             0             6
                                              High                              N/A           N/A
                                              Total Applications Scored             1            6

9
    Based on OIG analysis.



                                OIG  AUD-2013-012  September 27, 2013                               17
Overall, for the 12 bidders that were scored incorrectly, OIG found 22 instances of
noncompliance with the approved scoring criteria. Specifically, the following areas were not
scored by the bidder qualification contractor in accordance with the approved scoring criteria:

      Third-party documentation of funding, such as bank statements, was not provided in
       two instances. Nevertheless, the funding section was still scored satisfactory.
      Community relations component within the portfolio management plan section was
       incorrectly scored as satisfactory in three instances. For example, investors did not
       describe forward-looking community awareness initiatives, as required by the scoring
       criteria, or were incomplete in detailing their plans.
      Limited real estate experience based on the scoring criteria was scored satisfactory in
       thirteen instances.
      Asset managers and key management personnel were not identified in one instance;
       however, the component was scored satisfactory.
      Bidders required 30 and 45 days to secure funding when the approved scoring criteria
       required the availability of funds within 10 days or less in two instances; however, this
       component was scored satisfactory.
      Funding availability was incorrectly stated by the investor in one instance.
       Specifically, funds stated as available were in fact removed from an account prior to
       the end of the reporting period. Fannie Mae’s contractor did not amend the amount of
       available funds based on this information.

OIG also noted two areas of the application and scoring criteria that could use clarification
if used for similar programs in the future. First, although investors were required to submit
financial statements or acceptable alternative documentation to the qualification contractor,
a definition of what was considered acceptable alternative documentation was not provided.
Second, if the income statements contained any adverse data, such as continuing net losses,
scoring criteria stated that the adverse data must be explained in the notes to the financial
statements. However, the scoring criteria did not describe what factors should be considered
in deciding whether an investor with a record of net losses should be scored satisfactory
or how other adverse data should be addressed. Additionally, the criteria did not establish
documentation submission requirements to address adverse data such as capital and liquidity
plans.

   FHFA Did Not Independently Verify Applications or Scoring

This erroneous scoring might have been identified earlier had FHFA performed independent
verification of the bidder qualification contractor’s work. FHFA approved the scoring matrix
used by the contractor to score the applicants. In addition, the bidder qualification contractor


                            OIG  AUD-2013-012  September 27, 2013                                18
and Fannie Mae briefed FHFA on the scoring results and made recommendations concerning
which applicants should qualify to bid. Fannie Mae also represented to FHFA that the pool of
qualified bidders was selected in accordance with the approved scoring criteria and process.
However, FHFA accepted Fannie Mae’s and the contractor’s assertions and recommendations
without verifying either the veracity of the information in investor applications or the
performance of the bidder qualification contractor.

     Inconsistent Scoring Increases Risks

In discussions with Fannie Mae and its bidder qualification contractor, both repeatedly
explained that the criteria for scoring applications was meant to be as flexible as possible in
order to encourage and increase participation from multiple bidders. The scoring criteria were
intended to serve as a guideline for scoring in a consistent manner across multiple bidder
applications. However, not scoring bidders in accordance with the established scoring criteria
can have the opposite effect by reducing consistency across multiple bidders and creating an
unlevel playing field. For example, there are potential problems associated with strictly
enforcing scoring criteria for some, but not all, bidders. This creates a scenario in which
compliant bidders are potentially at a competitive disadvantage compared to noncompliant
bidders if the latter group is not excluded. Also, there were no clear provisions in the guidance
for how to assess and address the increased risk posed by bidders that did not meet the scoring
criteria.

     Two Unqualified Investors Subsequently Determined Eligible to Bid

Despite having in place criteria prohibiting the acceptance of bids from investors scored as
high risk, Fannie Mae, with FHFA concurrence, qualified two investors to bid on REO pools
after these investors had been scored by the bidder qualification contractor as high risk. FHFA
relied exclusively on Fannie Mae’s determination regarding the investors’ eligibility to bid
and approved these two high risk investors to submit bids without independent verification.

The two high risk bidders that Fannie Mae subsequently determined as qualified to bid were
found by the bidder qualification contractor to be unlike the other five high risk bidders. The
bidder qualification contractor identified factors that could offset risks identified.10 FHFA did
not review these potential offsetting factors to determine if they did in fact mitigate the risk
associated with these investors.

By allowing these two investors to bid when both received overall high risk ratings, the
established eligibility process was not followed and the undue risk of selecting a potentially

10
   The two bidders recommended to bid were scored high risk due to their negative credit outlook. The other
five high risk bidders that were not allowed to bid were determined to be high risk based on unsatisfactory
responses in other areas of the scoring criteria.



                                OIG  AUD-2013-012  September 27, 2013                                       19
unqualified bidder was introduced into the scoring process. Although neither of these high
risk investors subsequently submitted bids, both were afforded the opportunity to do so for the
initial pilot program pools and also could be considered to be qualified to participate in future
sales.

     Impact of Noncompliance with Bidder Criteria

FHFA established prescriptive bidder qualification requirements and processes for the pilot
program as key controls to ensure investors had the requisite financial capability, experience,
and expertise to successfully perform REO-related responsibilities. A senior FHFA official
stated in congressional testimony that the pilot program’s “rigorous application process is
intended to narrow the pool of eligible bidders to those who have financial and operational
expertise, but also the mission-oriented commitment to ensure that this program brings capital
to markets in need in a way that stabilizes communities.”11

In addition, a Treasury official testified that in order to ensure that the pilot program stabilizes
communities, the program must attract responsible property owners who will sustain the
repair and restoration of the hardest hit communities.12 This official noted that one control
built into the pilot program is the strict investor qualification requirements. Among these
requirements is assessing an investor’s ability to provide tenants with housing counseling
services and to provide credit bureaus with documentation related to a tenant’s timely
payment of rent so that those individuals hard hit by the financial crisis can rebuild their credit
scores more quickly. The official added that only those investors that meet the high standards
built into the qualification process would be permitted to bid on the enterprises’ portfolios.

A key process control regarding investor qualification as a bidder is verifying the financial
condition and amount of funding stated as available in the application package. The lack of
FHFA verification in these areas could result in the selection of an investor who is unable to
fund the bid price or financially support its REO-related operations.

     Scoring Process for Qualifying Pilot Program Investors Could Affect Future REO
     Disposition Initiatives

FHFA contracted for a program advisor to compile feedback from participants involved in the
pilot program and to provide advice to FHFA for possible similar transactions in the future.
One suggestion for future transactions was that FHFA should evaluate whether bidders that
qualified for this transaction should be exempted from having to participate in future

11
  Statement of FHFA Senior Associate Director for Housing and Regulatory Policy before the House
Subcommittee on Capital Markets and Government Sponsored Enterprises on May 7, 2012.
12
  Statement of Treasury Counselor to the Secretary for Housing Finance Policy before the House
Subcommittee on Capital Markets and Government Sponsored Enterprises on May 7, 2012.



                               OIG  AUD-2013-012  September 27, 2013                                 20
qualification processes. If FHFA follows this recommendation and automatically qualifies
REO Pilot Program bidders, bidders that were incorrectly qualified for the pilot would be
eligible to bid on similar transactions in the future.

   Summary

FHFA intended the bidder application process to be thorough in order to control the quality of
investors involved in the REO Pilot Program. However, because FHFA and Fannie Mae did
not ensure adherence to the agreed method of scoring, the scoring process was actually not as
rigorous as intended. As a result, several investors were qualified as bidders in spite of their
not meeting established scoring criteria, thus potentially jeopardizing the success of the REO
Pilot Program. As FHFA further develops its REO Disposition Program discussed in its FY
2013–2017 Strategic Plan, it is important that it establish oversight controls to ensure that the
bidders are in fact meeting the requirements set forth in program guidance. Additionally,
FHFA needs to clarify how to address the absence of bidder financial statements, particularly
regarding the financial condition of and availability of funding for prospective bidders and the
explanation of adverse financial information. Doing so will help ensure that a comprehensive
qualification process is in place.

2. FHFA’s Goals and Objectives for Overseeing the REO Disposition Program,
   Including the REO Pilot, Can Be Strengthened and Improved

FHFA has stated a number of goals and objectives intended to address key risks associated
with management of the enterprises’ current and forecasted REO inventory. Although each of
these goals and objectives is potentially significant, FHFA has not clarified the specific goals
that are applicable to the REO Pilot Program as compared to future REO disposition
initiatives, how the goals and objectives will be achieved, or how the agency intends to
monitor and assess the performance of both the pilot and any future initiatives against
established goals and objectives. In particular, FHFA has not prepared a program plan—to
guide its improvement initiatives as part of its overall REO disposition program—that
addresses these areas or responds to its stated intent to improve REO disposition activities.

   Goals and Objectives for REO Disposition Have Evolved

FHFA’s goals and objectives related to REO disposition have evolved over time. When
FHFA first announced its efforts to improve REO asset disposition in August 2011, the
agency stated its objectives were to achieve the following:

   1. Reduce the REO portfolios of the enterprises in a cost-effective manner;

   2. Reduce average loan loss severities to the enterprises relative to individual distressed
      property sales;


                            OIG  AUD-2013-012  September 27, 2013                                 21
   3. Address property repair and rehabilitation needs;

   4. Respond to economic and real estate conditions in specific geographies;

   5. Assist in neighborhood and home price stabilization efforts; and

   6. Suggest analytic approaches to determine the appropriate disposition strategy for
      individual properties, whether sale, rental, or, in certain instances, demolition.

In February 2012, the FHFA acting director, with Treasury concurrence, directed Fannie Mae
to execute the REO Pilot Program in accordance with the following goals and objectives:

   1. Reduce taxpayer losses,

   2. Stabilize neighborhoods and home values,

   3. Shift to more private management of properties, and

   4. Reduce the supply of REO properties in the marketplace.

In May 2012, an FHFA senior official conveyed the following goals for the REO pilot
program during congressional testimony:

   1. Gauge investor appetite for a new asset-class—scattered site single family rental
      housing—as measured by the price that investors are willing to pay for a traditionally
      high-value commodity that has been hampered by oversupply;

   2. Determine whether the disposition of properties in bulk, as opposed to one-by-one,
      presents an opportunity for well-capitalized investors to partner with regional and
      local property management companies and other community-based organizations to
      create appropriate economies of scale, yet provides civic-minded approaches that can
      stabilize and improve market conditions; and

   3. Assess whether the model can be efficiently replicated to make it a worthwhile
      addition to the standard retail and small-bulk sales strategies in place at the enterprises
      and other financial institutions with large inventories of properties to sell.

When program goals and objectives are unclear or shifting, it is progressively difficult to
assess whether the program is worthwhile and should be continued.

   Need for an REO Disposition Program Plan

Although the REO Pilot Program was authorized with specific—albeit shifting—objectives,
FHFA did not prepare accompanying guidance, such as a program plan, to guide either the


                            OIG  AUD-2013-012  September 27, 2013                                 22
initial REO Pilot Program or the planning and execution of any future REO property
disposition initiatives. In addition, there is no plan in place for monitoring and overseeing the
agency’s REO disposition program or initiatives. The following examples illustrate why the
various goals and objectives stated for the REO Pilot Program need to be clarified relative to
future REO disposition initiatives. In turn, such clarification can mitigate risks associated with
achieving the goals and objectives by laying out the actions to be taken and the means to
provide oversight and monitoring.

      One stated goal is to reduce the REO portfolios of the enterprises. However, under the
       current REO Pilot Program, Fannie Mae is still reporting the covered assets in the
       REO Pilot Program on its financial statements as the transactions do not meet sales
       accounting criteria. The bulk sale transactions in the program are based on an eight-
       year horizon to dispose completely of REO properties, with property sales restricted
       until the third anniversary following the closing date of the governing agreement.
       Therefore, the contribution of bulk REO sales with rental provisions to any near-term
       reductions in the REO portfolios requires clarification.
      Several goals refer to stabilizing neighborhoods through REO sales programs.
       However, Fannie Mae has noted that utilizing its retail sales channel rather than
       disposing of REO properties in bulk sales produces the most favorable execution
       strategy to help stabilize neighborhood home values. Specifically, Fannie Mae
       believes that selling to owner-occupants is a more effective means to stabilize
       neighborhoods. Approximately two-thirds of Fannie Mae’s REO properties are sold to
       owner-occupants. In addition, retail sales to owner-occupants often occur within 60
       days of the property being placed for sale and at close to market value—both of which
       contribute to neighborhood stabilization. Therefore, the benefits of how bulk REO
       sales help stabilize neighborhoods need further clarification.
      Several stated goals refer to reducing losses on REO property disposition. However,
       Fannie Mae has indicated that the REO Pilot Program represents 1% of their annual
       REO sales (roughly 200,000 properties). Further, in the current REO Pilot Program,
       Fannie Mae is responsible for most of the losses since it retains a 90% owner interest
       in the underlying assets. Fannie Mae sold a 10% interest in the transactions to each of
       the three bidders who are responsible for asset and property management functions.
       The bidders are compensated for these services through the rental income received on
       the properties with any resulting losses borne largely by the enterprise. Therefore, the
       approach to achieving a significant reduction in losses on REO property disposition
       should be further clarified.




                            OIG  AUD-2013-012  September 27, 2013                                  23
   REO Disposition Will Remain an FHFA Priority

REO disposition beyond the pilot program is seen as an agency priority, which further
necessitates that a detailed program plan be prepared. For example, disposition of REO is
addressed in FHFA’s FY 2013–2017 Strategic Plan. Specifically, the plan states that FHFA
will:

       Develop and implement an improved real estate owned (REO) disposition
       program for the Enterprises. FHFA will work with HUD and Treasury to
       consider new approaches to disposing of enterprise- and FHA-owned REO
       properties. Approaches will be tailored to the needs and economic conditions
       of local communities to bring greater stability to local housing markets.

   FHFA Previously Recommended Fannie Mae Establish a Governing Process for Pilot
   Programs

In March 2012, FHFA identified the lack of an enterprise-level plan for pilot programs as a
“Matter Requiring Attention” during an agency examination of Fannie Mae. FHFA examiners
recommended that Fannie Mae establish a governing process for pilot programs. This process
was defined as including goals and objectives, monitoring and tracking controls, and criteria
for determining if pilot programs should be continued.

In the context of REO, Fannie Mae responded that the pilot program utilizes current policies
and procedures already in place in its business unit as guidance. However, Fannie Mae stated
that it would finalize a process for establishing, approving, documenting, and tracking REO
pilot programs. Fannie Mae agreed to draft and finalize a policy and/or procedure to be used
for future pilot projects; the enterprise completed this action in June 2012. The policy
included the definition of a pilot program and requirements for pilot approval. Additionally,
the policy requires that pilots include goals and objectives; requirements for monitoring,
tracking, and reporting progress; and a timeframe for the pilot to be reviewed for termination,
extension, or conversion to a permanent program. Fannie Mae’s guidance is generic for any
future REO pilot program but does not address the current REO Pilot Program.

Moreover, Fannie Mae officials informed us that the enterprise has not implemented any pilot
projects with the exception of the REO Pilot Program, which it considered to be an FHFA
initiative with objectives and performance measures set by the agency rather than the
enterprise. In fact, Fannie Mae described its role in the pilot program as limited to operational
execution of the program and providing the properties to be included, with all program
activities under the direction and approval of FHFA. Accordingly, in order to fully complete
FHFA’s recommended action, the enterprise needs a better understanding of FHFA’s current
goals, objectives, and other expectations for the current pilot program as well as future REO



                            OIG  AUD-2013-012  September 27, 2013                                 24
disposition initiatives. Such goals, objectives, and expectations should be documented in a
comprehensive program plan prepared by FHFA. This program plan in turn could be used by
the enterprises to formalize their programs if it is decided to move forward with additional
REO disposition approaches, such as using bulk sales rather than retail sales in some cases.

   Oversight and Monitoring of Pilot Program

The Compliance and Governance Working Group of the IAWG reviewed and discussed two
levels of governance and compliance—one related to FHFA’s responsibilities at the program
level and the other related to enterprise responsibilities at the transaction level. In addition,
this group reviewed compliance and reporting requirements in the event financing was
provided as part of an REO Initiative transaction.

      Program Governance and Compliance—The working group proposed that program
       level governance and compliance requirements apply to all properties and transactions
       involved in the REO Initiative. It included uniform requirements and reporting for all
       submissions to FHFA and monitoring by FHFA regardless of who the transaction
       participants might be.
      Transactional Governance and Compliance—The working group proposed that
       transactional governance and compliance would apply to each specific transaction
       and would be a part of contracts between the parties to any transaction. Transaction
       compliance could be uniform or it could vary across different transactions.
This guidance is helpful in planning needed controls in future REO disposition activities.

Finally, Standards for Internal Control in the Federal Government promulgated by the
Comptroller General of the United States identify control activities, such as establishment
and review of performance measures, and monitoring of established controls in the course
of normal operations. To achieve these standards, FHFA can more clearly document how it
intends to achieve its control objectives for the REO disposition initiatives discussed in the
agency’s Strategic Plan.

   Summary

FHFA has not clarified the goals and objectives for the REO pilot program or future REO
disposition activities as the program has evolved. Also, neither FHFA nor Fannie Mae
took action to develop a detailed program plan for the REO Pilot Program or other REO
disposition initiatives that may comprise the agency’s REO disposition program. Without
clear direction from FHFA in the form of a program plan documenting goals and objectives
and an oversight and governance structure for the REO Pilot Program and future REO
disposition program activities, measuring the program’s effectiveness and, ultimately, its
success is impeded. For example, absent oversight of the REO Pilot Program, FHFA cannot


                            OIG  AUD-2013-012  September 27, 2013                                 25
ensure that Fannie Mae and winning bidders comply with bulk sale transaction terms. This is
critical due to the nature of the contract financing structure, asset management strategy,
property sale restrictions, property management provisions, and reporting requirements. Also,
although planned 2013 examination coverage is important to ensuring the safety and
soundness of Fannie Mae, it does not necessarily constitute the program level monitoring and
oversight needed to ensure proper disposition of the current REO inventory of over 96,000
properties at Fannie Mae and additional REO properties that may result from the almost
500,000 seriously delinquent single-family loans in Fannie Mae’s portfolio.

It is critical for FHFA to be diligent in overseeing and monitoring Fannie Mae and its winning
bidders to ensure the completeness of receipts from rentals and sales, contractor compliance
with applicable rental and housing regulations, REO vendor expenses and reimbursements,
and investigation of renter complaints against investors and contractors. As conservator,
FHFA has a responsibility to help ensure enterprise REO disposition is consistent with
conservatorship goals and can do so through clarifying and better documenting its goals and
objectives for the REO Pilot Program. Some of these issues were highlighted in FHFA’s most
recent targeted examinations of the enterprises’ REO vendor management.

The need for effective goals and objectives as well as sufficient oversight is further
compounded by the scope and length of the pilot program. For example, Fannie Mae
estimated higher sales proceeds with the current REO Pilot Program—potential REO cash
flow of $308 million versus $293 million for the retail disposition of the slightly over 2,300
REO properties in the REO Pilot Program—or a credit loss savings of $15 million over the
eight-year disposition schedule. Although this is a considerable benefit, achieving this
outcome depends on the coordinated action of multiple parties including FHFA, Fannie Mae,
and the three joint ventures. The REO Pilot Program’s bulk sales estimated future value is
based on rental rates and property sales that are not assured and will require considerable asset
and property management skills to achieve. Comparatively, REO retail sales may not incur
the same holding costs associated with maintaining the rental properties over extended
periods. Therefore, clear program guidance and comprehensive performance measurement
and monitoring are essential and can form key components of an overall FHFA program plan.




                            OIG  AUD-2013-012  September 27, 2013                                 26
CONCLUSIONS ..........................................................................

FHFA established a sound process for reviewing, scoring, and recommending investors to
qualify as bidders under the REO Pilot Program. However, Fannie Mae’s bidder qualification
contractor did not fully comply with important provisions of the established process. FHFA
also needs to address how to handle the absence of prospective bidder financial statements
and their submission of adverse financial information such as repeated losses.

Additionally, FHFA has stated a number of goals and objectives in connection with REO but
has not clarified the specific goals that are applicable to the REO Pilot Program as compared
to future REO disposition initiatives, how the goals and objectives will be achieved, or how
the agency intends to monitor and assess the performance of both the pilot and any future
initiatives against established goals and objectives. In particular, FHFA has not prepared a
program plan to guide its REO disposition-related initiatives that addresses these areas or
responds to its stated intent to improve the REO disposition program. Such planning is
important to provide the oversight needed to ensure proper disposition of Fannie Mae’s
current and future REO inventory.




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

OIG recommends that FHFA:

   1. Establish verification controls to ensure enterprise contractors are performing in
      accordance with agreed criteria and that any proposed waivers to the criteria are
      documented and submitted for FHFA review and approval.

   2. Clarify guidance regarding submission of financial statements and explanation of
      adverse financial events as part of the bidder qualification process.

   3. Issue formal guidance for the REO disposition program, including the REO Pilot
      Program, requiring a program plan with clearly defined goals and objectives, a
      program monitoring and oversight mechanism, criteria to measure and evaluate
      program success, and the means to assess alternative REO disposition strategies.




                           OIG  AUD-2013-012  September 27, 2013                              27
OBJECTIVE, SCOPE, AND METHODOLOGY .................................

The objective of this performance audit was to assess FHFA’s oversight of Fannie Mae’s
policies, procedures, and practices with respect to the selection and administration of
investors participating in the REO Pilot Program.

OIG performed fieldwork for this audit from November 2012 through July 2013. OIG
conducted this audit in Washington, D.C., at FHFA’s and Fannie Mae’s respective offices.
OIG interviewed personnel of FHFA, Fannie Mae, Fannie Mae’s third-party contractors, and
federal financial regulators.

The scope of OIG’s audit related to an assessment of the extent of FHFA’s oversight of
Fannie Mae’s REO Pilot Program. OIG relied on computer-processed and hardcopy data from
FHFA, Fannie Mae, Fannie Mae’s third-party contractors, and FHFA’s third-party contractor.

To achieve the audit objective, OIG:

      Interviewed FHFA management and Fannie Mae corporate and business unit
       personnel to obtain an understanding of the goals and objectives of the REO Pilot
       Program;
      Interviewed FHFA staff to understand and corroborate oversight, supervision, and
       guidance regarding the REO Pilot Program; and
      Obtained an understanding of the criteria used in the bidder qualification process and
       reviewed the selection process conducted by Fannie Mae’s third-party contractor.

OIG also assessed the internal controls related to the audit objective. Internal controls are an
integral component of an organization’s management that provides reasonable assurance that
the following objectives are achieved:

      Effectiveness and efficiency of operations,
      Reliability of financial reporting, and
      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, OIG considers deficiencies in FHFA’s oversight of Fannie Mae’s
policies, procedures, and practices with respect to the selection and administration of



                            OIG  AUD-2013-012  September 27, 2013                                28
investors participating in the REO Pilot Program to be significant in the context of the audit’s
objective.

OIG conducted this performance audit in accordance with generally accepted government
auditing standards. Those standards require that OIG plan audits and obtain sufficient,
appropriate evidence to provide a reasonable basis for 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 OIG’s audit objective.




                            OIG  AUD-2013-012  September 27, 2013                                29
APPENDIX A .............................................................................

FHFA’s Comments on OIG’s Findings and Recommendations




                        OIG  AUD-2013-012  September 27, 2013                        30
OIG  AUD-2013-012  September 27, 2013   31
OIG  AUD-2013-012  September 27, 2013   32
APPENDIX B..............................................................................

OIG’s Response to FHFA’s Comments

On September 12, 2013, FHFA provided comments to a draft of this report. FHFA agreed
with Recommendations 1, 2, and 3 and identified corrective actions to be taken to the extent
there are any subsequent REO disposition transactions similar to the REO Pilot Program. OIG
has attached FHFA’s full response as Appendix A and considered it where appropriate in
finalizing this report. Appendix C provides a summary of the agency’s response to OIG’s
recommendations and the status of agreed-upon corrective actions.

Overall, FHFA management agreed that strategies and procedures associated with any
subsequent REO structured bulk sale program require refinement based on the lessons learned
from the initial REO bulk sale, referred to in this report as the REO Pilot Program. FHFA
stated that these refinements would serve to enhance the bulk sale program terms, including
the bidder qualification scoring methodology, and would serve as the foundation for
formalizing a program plan including strategies and success measures.

OIG considers FHFA’s responses to Recommendations 1 and 2 to be sufficient to resolve the
recommendations. Because any corrective actions are contingent on utilizing a future REO
disposition transaction similar to the REO Pilot Program, the recommendations are considered
to be closed upon issuance of this final report.

With respect to Recommendation 3, the agency agreed to issue formal guidance including a
program plan and success measures if a decision is made to pursue additional transactions
under an REO structured bulk sale program. Although such action is notable, an important
aspect of this recommendation is defining the means to assess alternative REO disposition
strategies in order to support decisions concerning disposition transactions that should be
pursued. The need exists to define the means to perform these assessments before decisions
are actually made regarding future REO transactions. Consequently, OIG considers
Recommendation 3 to be resolved given the agency’s commitment to formalize a program
plan but requests that, within 30 days of issuance of this report, FHFA provide clarification
regarding agency actions to develop a means to assess alternative REO disposition strategies.

Additionally, FHFA indicated in its response that OIG’s finding related to the scoring
methodology was actually directed to the design of the bidder qualification scoring
methodology rather than the execution of that methodology. OIG assessed both the design and
execution of the scoring methodology including the scoring criteria used. For example, the
bidder qualification scoring criteria for funding requires the bidder to provide supporting
documentation. Specifically, the criteria stated that third party documentation (e.g., bank


                           OIG  AUD-2013-012  September 27, 2013                              33
statements, etc.) must be provided to support the availability of the funds identified in the
bidder’s application. This third party documentation of funding was required so that when
bids were received, the bid amount for the potentially winning bidder could be compared to
the funding documentation provided by the bidder to ensure the bidder has the financial
capability to perform in accordance with the resulting contract. In this case, OIG reviewed
both the methodology and criteria for determining funding availability and the execution of
these controls through review of bidder information received and the use of that information
in the scoring process.

FHFA also asserted in its response that the OIG audit report seems to confuse the objectives
and scope of the overall REO disposition strategies of the enterprises and the REO Pilot
Program. Finding 2 identifies how the objectives of various REO-related activities have
evolved over time and the importance of FHFA defining its expectations in this critical area
in order to avoid any confusion regarding future REO disposition initiatives. Therefore, the
intent of Recommendation 3 is for FHFA to clarify the goals and objectives of FHFA’s
overall REO disposition program as well as the program monitoring and oversight
mechanisms and criteria to measure and evaluate program success. Such action will help
distinguish the roles and responsibilities of the agency and the enterprises and result in
FHFA’s disposition program driving the REO disposition strategies of the enterprises as it
did with regard to the REO Pilot Program.




                           OIG  AUD-2013-012  September 27, 2013                              34
APPENDIX C ..............................................................................

Summary of FHFA’s Comments on the Recommendations

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
        If a decision is made to utilize a similar
        transaction, FHFA will establish
    1   appropriate controls to ensure                        N/A           $0           Yes          Closed
        contractors are performing in
        accordance with agreed criteria.
        FHFA agrees that, based on lessons
        learned from this transaction, additional
        guidance would be provided to bidders
    2   as to what would be considered an                     N/A           $0           Yes          Closed
        acceptable financial statement and
        bidder explanation as part of any future
        structured bulk sale transaction.
        FHFA management has not decided to
        formalize an REO Pilot Program;
        however, if a decision is made to utilize
        a similar transaction, FHFA will issue
        formal guidance. Refinements to
        program terms, including bidder
    3   qualification, would serve as the                     N/A           $0           Yes          Open
        foundation for a program plan including
        strategies and success measures.
        Clarification is requested within 30 days
        regarding agency actions to develop a
        means to assess alternative REO
        disposition strategies.
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-2013-012  September 27, 2013                                         35
APPENDIX D .............................................................................

2012 YTD REO Inventory Inflow and Outflow13




13
     Source: Fannie Mae, “FHFA REO Pilot Lessons Learned,” December 4, 2012.



                                OIG  AUD-2013-012  September 27, 2013                36
APPENDIX E ..............................................................................

REO Pilot Program Timeline of Events14




14
     Source: OIG Analysis.



                             OIG  AUD-2013-012  September 27, 2013                    37
ADDITIONAL INFORMATION AND COPIES .................................


For additional copies of this report:

      Call: 202–730–0880
      Fax: 202–318–0239
      Visit: www.fhfaoig.gov



To report potential 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-2013-012  September 27, 2013                        38