oversight

FHFA Oversight of Fannie Mae's Remediation Plan to Refund Contributions to Borrowers for the Short Sale of Properties

Published by the Federal Housing Finance Agency, Office of Inspector General on 2014-01-15.

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

          Federal Housing Finance Agency
              Office of Inspector General




FHFA Oversight of Fannie Mae’s
  Remediation Plan to Refund
Contributions to Borrowers for the
     Short Sale of Properties




 Audit Report  AUD-2014-004  January 15, 2014
                                         January 15, 2014


TO:            Jon D. Greenlee, Deputy Director, Division of Enterprise Regulation

FROM:          Russell A. Rau, Deputy Inspector General for Audits


SUBJECT:       FHFA Oversight of Fannie Mae’s Remediation Plan to Refund Contributions to
               Borrowers for the Short Sale of Properties


Background

The Federal National Mortgage Association (Fannie Mae or Enterprise) is a federally chartered
corporation that was placed in conservatorship by the Federal Housing Finance Agency (FHFA
or Agency) in September 2008 due largely to losses on residential mortgage loans from defaults.
While in conservatorship, FHFA has the decision-making authority in addition to its
responsibilities as a regulator for the Enterprise. Short sales, also known as preforeclosure sales,
are a part of Fannie Mae’s foreclosure alternative strategy that can minimize the severity of
losses it incurs as a result of loan defaults. In a short sale, the borrower sells the residence for
less than the balance remaining on the loan and uses the proceeds to help satisfy the mortgage
obligation. The proceeds received from a short sale are less than the amount of debt secured by
liens against the property, which most often results in a loss to the Enterprise. In certain short
sale transactions, depending on the borrower’s financial condition, the borrower may be required
to make a contribution toward the short sale, which in turn reduces the Enterprise’s loss on the
sale.

Through their Seller/Servicer Guides, Fannie Mae and Freddie Mac provide guidance on a large
number of matters, including delinquency management and default prevention. Servicers are
required to comply with the guidance through their contractual agreements with the Enterprises.
The Enterprises have quality control processes that are designed to identify and address servicer
noncompliance and the contracts include remedial tools, such as financial penalties. Pursuant
to its delinquency management and default prevention guidance, Fannie Mae expects servicers
to identify borrowers who are having difficulty making mortgage payments due to a financial
hardship and offer appropriate workout options, such as a short sale. Fannie Mae also depends on
its servicers to evaluate borrowers for contributions unless they are required to request approval
from Fannie Mae for the contribution amount. Furthermore, Fannie Mae relies on its servicers to
collect borrower contributions with the net proceeds from the short sale closing.


   Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
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Before Fannie Mae clarified the requirements for borrower contributions, there was little
guidance for servicers to follow with respect to requesting contributions and collecting them.
On August 22, 2012, Fannie Mae issued Servicing Guide Announcement SVC-2012-19 that
introduced new requirements to simplify and streamline the short sale process.1 This
announcement provided specific guidance for evaluating a borrower for a contribution and
reminded servicers that they must not request cash contributions and/or promissory notes where
applicable law prohibited borrower contributions; however, it did not state that borrower
contributions were prohibited in California.

Although Fannie Mae issued guidance to its servicers informing them of the requirements for
evaluating borrower contributions, Fannie Mae and its servicers did not always have the option
to collect them. On September 30, 2010, the state of California enacted a law which went into
effect on January 1, 2011, that prohibited a deficiency judgment for any note where the property
sold for less than the indebtedness.2 According to Fannie Mae, the language of this new law was
unclear and did not expressly prohibit borrower contributions in short sale transactions.

On July 11, 2011, the state of California amended Section 580e on an emergency basis to
provide clarity in connection with borrower contributions on short sale transactions. The
amendment, which went into effect four days later on July 15, clarified the law to include an
express prohibition against any type of borrower contribution in connection with a short sale.
Specifically, Section 580e subsection (b) forbids “A holder of a note” from requiring the
borrower “to pay any additional compensation, aside from the proceeds of the sale, in exchange
for the written consent to the sale.”

Fannie Mae and its servicers were also prohibited from collecting contributions for short sales
completed through Fannie Mae’s Home Affordable Foreclosure Alternatives (HAFA) Program
that went into effect on August 1, 2010.3 Fannie Mae’s HAFA Program was discontinued with
the implementation of the Standard Short Sale Program on November 1, 2012, which was
created as part of FHFA’s Servicing Alignment Initiative (SAI).4



1
 Servicing Guide Announcement SVC-2012-19 is entitled, “Standard Short Sale/HAFA II and Deed-in-Lieu of
Foreclosure Requirements.”
2
  This law, Section 580e of the California Code of Civil Procedure, provides that a deficiency judgment shall not be
rendered for any note secured by a first lien where the property is sold for less than the amount of the indebtedness
with the written consent of the mortgagee, if certain conditions are satisfied. CAL. CIV. PROC. § 580e(a)(1).
3
  Section 610.02.01 of Fannie Mae’s 2012 Servicing Guide prohibits borrower contributions for HAFA short sales.
The guide states that “Cash contributions or promissory notes are not permitted under HAFA; therefore, if a servicer
or mortgage insurer determines that a borrower has an ability to contribute meaningfully to reducing the potential
loss on the mortgage loan, the borrower is not eligible for HAFA and may only obtain a preforeclosure sale or deed-
in-lieu under the requirements of other Fannie Mae preforeclosure sale or deed-in-lieu alternatives.” See Fannie Mae
Single Family 2012 Servicing Guide Part VII, § 610.02.01.
4
 The SAI establishes consistent policies and processes for the servicing of delinquent loans owned or guaranteed by
Fannie Mae and Freddie Mac (the Enterprises).




    Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
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Finding: FHFA Should Oversee Fannie Mae’s Remediation Plan to Refund Contributions
to Borrowers for the Short Sale of Properties

Through its review of closed short sale transactions in a recently completed audit on short sale
borrower eligibility,5 OIG found that Fannie Mae and its servicers may have improperly
collected borrower contributions for short sales of properties on two fronts—in the state of
California and under the HAFA Program, which was available in all states. The collection of
these borrower contributions prompted Fannie Mae to initiate a remediation plan to return up to
$3,173,249 to borrowers who may have been impacted from the short sale of properties located
in California and up to $53,000 for HAFA short sales.

As of July 15, 2011, the state of California expressly prohibited the holder of a note from
requiring the borrower to pay any additional compensation in exchange for the written consent to
a sale other than the sale’s proceeds. This would include the collection of borrower contributions
as a condition of a short sale. Nonetheless, based on a review of short sale data provided by
Fannie Mae, it appeared that Fannie Mae’s servicers collected borrower contributions for 124
short sales completed during 2012 that would be contrary to the amended California law. Upon
identifying this issue, OIG followed up with Fannie Mae to identify all short sales of California
properties where borrower contributions were collected since the law became effective on
January 1, 2011.

As reflected in Figure 1, Fannie Mae provided the OIG with data showing that 1,222 borrower
contributions may have been improperly collected for the short sale of California properties
closed between January 1, 2011 and June 30, 2013. The contributions were either cash or
promissory notes executed by borrowers to pay the contribution over time. However, Fannie
Mae has advised that there are significant data accuracy issues and has identified a number of
short sales where the data reported to Fannie Mae by its servicers erroneously reflects the
collection of a borrower contribution. Therefore, the total number and amount of borrower
contributions improperly collected may be substantially less than the data supplied by Fannie
Mae.




5
 See OIG, Fannie Mae’s Controls Over Short Sale Eligibility Determinations Should be Strengthened, AUD-2014-
003 (November 20, 2013), available at http://www.fhfaoig.gov/Content/Files/AUD-2014-003.pdf.




    Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
                                                     3
                           FIGURE 1. Borrower Contributions for California Short Sales

                                                                                 No. of          Total Amount
                                Contribution Type                             Contributions        Collected
                            6
       Cash – Delegated                                                                 900         $1,903,880
       Cash – Non-delegated                                                             288            $897,311
       Promissory Note 7                                                                 34            $372,058
       Total Contributions for Properties Located in California                       1,222         $3,173,249


Fannie Mae completed an analysis of the California law on March 28, 2011. Fannie Mae
determined that it would not collect borrower contributions in connection with non-delegated
cases involving the short sale of properties located in California, despite the lack of clarity in the
law before it was amended in July 2011. Nonetheless, Fannie Mae did not issue any guidance to
its servicers regarding its decision to cease requesting borrower contributions for short sales of
California properties or to require them to adopt a consistent practice. Instead, it relied on its
servicers to comply with all federal, state, and local laws per its Servicing Guide and make their
own legal determinations.8 In addition, Fannie Mae did not enhance its own controls to identify
short sales in California with borrower contributions and monitor servicer compliance with the
California law prohibiting collection of such contributions until May 2013.9

Consequently, the controls in place at Fannie Mae did not prevent the potential inappropriate
collection of borrower contributions contrary to California law until they were enhanced toward
the end of May 2013. Fannie Mae’s servicers collected borrower contributions on its behalf for
the short sale of properties located in California after the law went into effect on January 1, 2011,
and, to a lesser extent, continued to collect them after the law was clarified and expressly
prohibited any type of borrower contribution as of July 15, 2011. Such cash contributions should
be potentially returned to the borrowers. Further, as previously discussed, Fannie Mae’s servicers
inappropriately executed promissory notes on its behalf for the collection of contributions from


6
  Fannie Mae has two categories of servicers, non-delegated and delegated. Non-delegated servicers have no
authority to make short sale decisions on behalf of Fannie Mae. Their role is limited to collecting short sale
information and forwarding the information to Fannie Mae for consideration. Delegated servicers have been granted
authority to make short sale determinations and complete short sales on behalf of Fannie Mae subject to certain
limitations in Fannie Mae’s Servicing Guide.
7
    Cash contributions were also paid by the borrowers for six of these short sales.
8
    See Fannie Mae Single Family 2012 Servicing Guide Part I,§ 307.
9
  At the end of May 2013, Fannie Mae implemented a daily exception report to identify all short sales where
contributions were received in connection with the short sale of properties located in California. Fannie Mae has
also implemented a secondary control to review the Settlement Statement (HUD 1) for properties sold short in
California to identify whether a borrower contribution was received. The HUD 1 is a form used by a settlement
or closing agent itemizing all charges imposed on a borrower and seller in a real estate transaction. Additionally,
Fannie Mae’s short sale letters to California borrowers will be updated with language that indicates borrower
contributions are prohibited.




     Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
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borrowers in California that should be discontinued and assessed for repayment of amounts
received.

In addition, based on a review of short sales data provided by Fannie Mae, it appeared that
Fannie Mae’s servicers improperly collected borrower contributions totaling $53,000 for 18 short
sales under Fannie Mae’s HAFA Program, which has since been discontinued.10 Based on data
provided by its servicers, Fannie Mae approved 6 of these short sales and its servicers approved
12. Fannie Mae’s Servicing Guide specifically prohibited borrower contributions for HAFA
short sales.

Based on OIG’s work, Fannie Mae was made aware that borrower contributions collected for
properties located in the state of California may be contrary to California law and that borrower
contributions collected for HAFA short sales are in violation of HAFA Program requirements. In
response, Fannie Mae acknowledged the importance of the issue and developed a Remediation
Plan that was finalized during October 2013 to notify its servicers to refund the borrowers the
amount of any improper contributions for the short sale of properties located in California that
were closed on or after January 1, 2011. A remediation plan is also in place for the HAFA short
sales where borrower contributions were collected.

Pursuant to its remediation plan, Fannie Mae sent a list of loans to each of its servicers that
collected borrower contributions. The servicers have been requested to research the amount of
the actual contributions collected and respond to Fannie Mae by December 31, 2013, identifying
the loans that would require a servicer refund for any improper borrower contribution. Upon
validation of each contribution, Fannie Mae will refund the amount of the contributions to its
servicers. Fannie Mae further explained that the decision to pursue refunds rests with each
servicer that reviews the identified cases where improper borrower contributions may have been
collected. If the servicer validates that a contribution was not collected or if the servicer has a
reasonable basis to support the contribution, a borrower refund may not be required by Fannie
Mae. The servicers would also presumably decide whether they believe there was a reasonable
basis to collect contributions made while the California law was unclear. As a result, the current
remediation plan may not provide for consistent treatment of borrowers by servicers even if
borrower circumstances are similar. For example, two large servicers have already taken the
legal position that refunds are not warranted for contributions collected prior to July 15, 2011,
the effective date of the amended California law. Fannie Mae has received eight requests for the
reimbursement of borrower contributions and is evaluating whether refunds should be paid to the
borrowers.

FHFA is currently reviewing Fannie Mae’s remediation plan to ensure that borrowers are
protected and made whole due to inappropriate borrower contributions. Additionally, FHFA will
determine if similar conditions exist at the Federal Home Loan Mortgage Corporation (Freddie
Mac) that uses most of the same servicers as Fannie Mae and similarly is handling defaulted
loans in California. Like Fannie Mae, Freddie Mac is regulated by FHFA and was placed into

10
   Fannie Mae informed the OIG that it collected borrower contributions for 16 of the 18 HAFA short sales and that
the difference between the data provided to the OIG and actual collections was the result of data input errors.




     Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
                                                        5
conservatorship by the Agency in September 2008. FHFA’s timely review of Fannie Mae’s
remediation plan will help ensure the consistent treatment of borrowers by Fannie Mae and its
servicers.

Recommendations

OIG recommends that FHFA:

      1. Review Fannie Mae’s remediation plan to ensure that the plan provides for the return of
         borrower contributions to borrowers in a consistent manner by Fannie Mae and its
         servicers, and issue guidance as deemed appropriate regarding the execution of the
         remediation plan.

      2. Oversee the execution of Fannie Mae’s remediation plan to ensure that a good faith
         effort is made to promptly refund inappropriately collected borrower contributions to
         borrowers.

      3. Examine Freddie Mac’s controls over the collection of borrower contributions for the
         short sales of properties located in California and issue guidance to strengthen controls as
         deemed appropriate based on the results of the examination.

Objective, Scope, and Methodology

The objective of this overall performance audit was to assess FHFA’s oversight of Fannie Mae’s
controls over borrower eligibility requirements applicable to its short sale program.11 During the
performance of fieldwork, OIG identified that in certain instances borrower contributions were
collected on short sales of properties located in California, a state with a law that expressly
prohibits this practice. Accordingly, OIG is separately reporting on Fannie Mae’s collection of
borrower contributions with an emphasis on those collected in the state of California.

OIG conducted its fieldwork at FHFA’s headquarters in Washington, D.C., and Fannie Mae’s
corporate offices in Washington, D.C. and Dallas, TX.

In order to accomplish its objective, OIG:

          Reviewed FHFA’s guidance to the Enterprises related to the short sales program;
          Reviewed Fannie Mae’s policies and procedures related to the short sales process;
          Interviewed FHFA and Fannie Mae officials to further OIG’s understanding of the
           short sale process;




11
     See footnote 5, supra.




     Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
                                                   6
      Reviewed and analyzed Fannie Mae short sales completed in 2012 and additional
       borrower contribution information for short sales closed from January 1, 2011 through
       May 31, 2013; and
      Interviewed seven Fannie Mae servicers concerning the short sale process.

OIG conducted fieldwork for this performance audit from January 2013 through October 2013
in accordance with Generally Accepted Government Auditing Standards. Those standards
require that OIG plan and perform audits to obtain sufficient, appropriate evidence to provide a
reasonable basis for the findings and conclusions based on the audit objective. OIG believes that
the evidence obtained provides a reasonable basis for the finding and conclusions included
herein, based on the audit objective.

OIG appreciates the cooperation of everyone who contributed to this audit, including officials at
FHFA and Fannie Mae. This audit was led by Laura Benton, Audit Director, and Scott H. Smith,
Audit Manager, who were assisted by Cairo Carr, Auditor-in-Charge, and Mendy Breitkopf,
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.



Attachments: Attachment A: FHFA’s Comments
             Attachment B: OIG’s Response to FHFA’s Comments
             Attachment C: Summary of Management’s Comments on the Recommendations




  Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
                                                7
Attachment A

FHFA’s Comments




  Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
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Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
                                             9
Attachment B

OIG’s Response to FHFA’s Comments

On January 9, 2014, FHFA provided comments to a draft of this report. Although FHFA stated it
agreed with OIG’s three recommendations, the Agency’s actions are not fully responsive and the
recommendations are unresolved. In particular, FHFA actions provide limited confidence that
borrowers will be treated consistently in decisions concerning refunds of their contributions to
short sales.

Although FHFA stated it agrees with Recommendations 1 and 2, its comments suggest
otherwise. While OIG recommended that FHFA provide guidance and oversight for the return of
borrower contributions, FHFA stated it would monitor execution of Fannie Mae’s remediation
plan. FHFA’s reliance on Fannie Mae’s representation and warranty framework model will not
provide for the return of borrower contributions in a consistent manner as OIG recommended.
Under this framework, each servicer will independently interpret the California law and decide
whether to return contributions to impacted borrowers. In particular, the servicers would
decide whether contributions made prior to amendments to California law would be refunded.
Therefore, different servicers could come to varying conclusions about refunding contributions
even if borrower circumstances are similar. Fannie Mae’s remediation plan provides for
reimbursement of all borrower contributions refunded by the servicers. Therefore, the servicers
will not experience a loss for refunding borrower contributions. However, this action by the
Enterprise alone will not be sufficient to cause servicers to refund contributions in a consistent
manner. For example, two large servicers have already taken the legal position that refunds are
not warranted for contributions collected before amendments to California law went into effect.
The OIG considers it necessary for FHFA and Fannie Mae to actively engage in oversight of
this effort including issuing appropriate guidance to ensure that borrowers receive consistent
treatment by servicers concerning refund of borrower contributions.

FHFA stated it agrees with Recommendation 3 and has already notified Freddie Mac that
servicers operating in California may face the same operational issues as Fannie Mae’s servicers.
FHFA also plans to review Freddie Mac’s oversight of servicers’ collection of borrower
contributions for the short sale of properties located in California and will provide OIG an update
on the results by April 15, 2014. OIG views FHFA’s actions as positive steps. However, just as
with Fannie Mae’s approach, OIG is concerned that servicers will come to varying conclusions
about refunding contributions and not provide consistent treatment to borrowers in similar
circumstances without guidance and oversight from FHFA and Freddie Mac.

OIG requests that FHFA reconsider its position on these three recommendations and provide
additional comments within 30 days of the issuance of this report. 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
corrective actions.




  Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
                                                10
OIG also noted that in footnote 1 of FHFA’s response, the Agency provided various comments
regarding compliance with federal and state law, including the relationship between state law and
conservator directed policies of the Enterprises.




  Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
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Attachment C

Summary of Management’s Comments on the Recommendations

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

                                               Expected      Monetary
 Rec.       Corrective Action: Taken or       Completion      Benefits      Resolved:     Open or
 No.                  Planned                    Date       ($ Millions)    Yes or No a   Closed b
1.       FHFA agrees with this               06/15/2014    $0              No             Open
         recommendation. Nonetheless,
         FHFA proposes to allow Fannie
         Mae to rely on its
         representation and warranty
         framework, which does not
         necessarily provide for the
         return of borrower contributions
         in a consistent manner. Further,
         FHFA is not planning on issuing
         additional guidance on this
         matter.
2.       FHFA agrees with this               06/15/2014    $0              No             Open
         recommendation. See response
         to Recommendation 1.
3.       FHFA agrees with this               04/15/2014    $0              No             Open
         recommendation. FHFA has
         informed Freddie Mac of this
         matter and will review the
         Enterprise’s current oversight of
         servicers’ collection of borrower
         contributions for the short sale
         of properties located in
         California and follow-up any
         identified deficiencies through
         its normal supervisory process.
         FHFA will provide OIG an update
         on the results by April 15, 2014.
         OIG is concerned that without
         proper oversight and guidance
         by FHFA and Freddie Mac, there
         may be inconsistent treatment
         of borrowers and untimely
         refunding of improperly
         collected contributions.


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a
 Resolved means: (1) Management concurs with the recommendation, and the planned, ongoing, and 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.




    Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
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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




   Federal Housing Finance Agency Office of Inspector General • AUD-2014-004 • January 15, 2014
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