oversight

FHFA Oversight of Fannie Mae's Collection of Funds from Servicers that Closed Short Sales Below the Authorized Prices

Published by the Federal Housing Finance Agency, Office of Inspector General on 2014-08-07.

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
Collection of Funds from Servicers
that Closed Short Sales Below the
         Authorized Prices




Audit Report  AUD-2014-015  August 7, 2014
                 FHFA Oversight of Fannie Mae’s Collection of Funds
                 from Servicers that Closed Short Sales Below the
                 Authorized Prices

                 Why OIG Did This Report
                 The Federal Housing Finance Agency (FHFA or Agency) currently serves
                 as both the regulator and conservator of the Federal National Mortgage
  At A           Association (Fannie Mae or Enterprise) and the Federal Home Loan Mortgage
 Glance          Corporation (Freddie Mac). As conservator, FHFA’s responsibilities are to
                 preserve and conserve Fannie Mae’s assets. Short sales are part of Fannie
   ———           Mae’s loss mitigation strategy to pursue foreclosure alternatives in order to
                 help minimize the severity of losses it incurs as a result of loan defaults.
August 7, 2014
                 Between August 2010 and December 2013, Fannie Mae and its servicers
                 closed over 210,000 short sales.

                 This report focuses on the effectiveness of FHFA’s oversight and Fannie
                 Mae’s controls over delegated servicers to ensure that net proceeds received
                 for short sales met the minimum amount authorized by Fannie Mae.

                 What OIG Found
                 In January 2014, Fannie Mae determined that between August 2010 and
                 December 2013, 4,883 short sale transactions were potentially closed in
                 violation of servicer delegations of authority, because the net proceeds from
                 the sales were less than the authorized minimum net reserve (MNR)
                 established by Fannie Mae. Fannie Mae analyzed these transactions and
                 determined that only 2,434 of them with MNR shortfalls of $16,955,656
                 should be included in a remediation plan. Nearly half of these transactions
                 were removed for one of three reasons: (1) they would have been approvable
                 if properly submitted to Fannie Mae for approval, (2) they had already been
                 remedied through a make whole agreement or repurchase, or (3) they had
                 actually received Fannie Mae review prior to the sale.

                 Fannie Mae then applied a series of four exclusions to the 2,434 short sale
                 transactions included in its remediation plan that reduced the number of
                 transactions the Enterprise would consider for pursuing an indemnification
                 demand to 453, with a total MNR shortfall of $10,818,979. Despite Fannie
                 Mae’s authority to require indemnification for each transaction with an MNR
                 shortfall, a decision was made to exclude 1,740 transactions with MNR
                 shortfalls of $6,136,677 and 241 transactions where an MNR value was not
                 obtained by the servicer.
                 Fannie Mae furnished OIG with a revised remediation plan just prior to the
                 release of this report. While the plan did in fact remove delegated transactions
                 erroneously included for remediation, the methodology of the plan remained
                 substantially unchanged from the initial version that was the basis for this
                 report. Further, the plan did not address potential shortfalls in non-delegated
                 short sale transactions where Fannie Mae retains approval authority.

                 Fannie Mae went to considerable lengths to demonstrate why it should not
  At A           pursue servicer noncompliance rather than emphasize the importance of
 Glance          established controls. Additionally, Fannie Mae did not fully address this lack
                 of servicer compliance through consideration of penalties, including, for
   ———           example, interest on shortfalls collected and recoupment of incentive fees
                 for completing short sale transactions.
August 7, 2014
                 What OIG Recommends
                 OIG recommends that FHFA communicate a written supervisory expectation
                 to Fannie Mae requiring that its business units perform a review of non-
                 delegated short sale transactions to identify any transactions where the servicer
                 submitted net proceeds that were less than the sale amount approved by Fannie
                 Mae and draft a remediation plan, as appropriate. OIG further recommends that
                 FHFA communicate a written supervisory expectation to Fannie Mae requiring
                 its internal audit group to review Fannie Mae’s plan to collect funds for
                 delegated and non-delegated short sale transactions where the net proceeds
                 received were less than the amounts authorized by Fannie Mae. Additionally,
                 OIG recommends that FHFA analyze Fannie Mae actions and remediation
                 plans regarding delegated and non-delegated short sale transactions to
                 determine whether Fannie Mae has taken necessary steps to ensure that
                 servicers are held accountable for servicing violations and credit losses are
                 minimized, including by assessing appropriate penalties and recouping
                 incentive fees paid for improperly closed short sale transactions.

                 FHFA agreed with OIG’s recommendations. To the extent that the above
                 actions result in monetary benefits, OIG will be reporting those amounts in its
                 semiannual report to Congress.
TABLE OF CONTENTS ................................................................
AT A GLANCE ...............................................................................................................................2

ABBREVIATIONS .........................................................................................................................5

PREFACE ........................................................................................................................................6

CONTEXT .......................................................................................................................................7
      Short Sale Pricing Process ........................................................................................................7
      Remedies Available to Fannie Mae in the Event of Servicing Guide Violations ....................8
      Fannie Mae Identification of Short Sale Control Failures and Servicing Violations ...............8

FINDING .........................................................................................................................................9
      Fannie Mae’s Servicers Did Not Always Close Short Sales at the Authorized Price
      and Fannie Mae’s Remediation Plan Does Not Hold Servicers Fully Accountable for
      the Resulting Loss.....................................................................................................................9
              Operational Incident Involving Delegated Short Sales.....................................................9
              Fannie Mae’s Remediation Plan .....................................................................................10
              Fannie Mae Has the Authority to Issue an Indemnification Demand to Servicers
                  that Incurred MNR Shortfalls and Penalize Them ..................................................13

CONCLUSIONS............................................................................................................................15

RECOMMENDATIONS ...............................................................................................................16

OBJECTIVES, SCOPE, AND METHODOLOGY .......................................................................17

APPENDIX A ................................................................................................................................19
      FHFA’s Comments on OIG’s Findings and Recommendations ............................................19

APPENDIX B ................................................................................................................................21
      OIG’s Response to FHFA’s Comments .................................................................................21

APPENDIX C ................................................................................................................................23
      Summary of FHFA’s Comments on the Recommendations ..................................................23

ADDITIONAL INFORMATION AND COPIES .........................................................................25



                                            OIG  AUD-2014-015  August 7, 2014                                                                 4
ABBREVIATIONS .......................................................................

Agency or FHFA        Federal Housing Finance Agency

BPO                   Broker Price Opinion

Fannie Mae or
Enterprise            Federal National Mortgage Association

MANP                  Minimum Acceptable Net Proceeds

MNR                   Minimum Net Reserve

NSO                   National Servicing Organization

OIG                   Federal Housing Finance Agency Office of Inspector General

REAM                  Real Estate Asset Management

SQR                   Servicer Quality Review




                          OIG  AUD-2014-015  August 7, 2014                       5
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
activities pertaining to FHFA’s programs and operations. As a result of its 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.

Short sales are Fannie Mae’s primary foreclosure alternative to mitigate losses. This audit
report is a part of OIG’s proactive audit and evaluation strategy to assess the Agency’s related
oversight and conservatorship efforts. The audit focused on the effectiveness of FHFA’s
oversight and Fannie Mae’s controls over delegated servicers to ensure that net proceeds
received for short sales met the minimum amount authorized by Fannie Mae.

OIG found that Fannie Mae’s servicers did not always close short sales at the authorized
price, and Fannie Mae’s remediation plan does not hold these servicers fully accountable for
the resulting losses. This report’s recommendations can increase FHFA’s assurance that
Fannie Mae’s assets are being preserved and conserved.

OIG appreciates the cooperation of all those 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 Jacob
Trewe, 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-2014-015  August 7, 2014                                  6
CONTEXT ..................................................................................

Short Sale Pricing Process

Fannie Mae seeks to preserve and conserve its assets through foreclosure alternatives
designed to mitigate losses from defaults on residential mortgage loans. Short sales, also
known as pre-foreclosure 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 a residence for less than the amount of debt secured by liens against the
property, which most often results in a loss to the Enterprise.

The minimum amount that Fannie Mae will accept for a delegated short sale is known as the
Minimum Net Reserve (MNR).1 Through its delegations of authority, Fannie Mae has granted
certain servicers the authority to close short sale transactions without its approval if the net
proceeds from the transaction meet or exceed MNR. Fannie Mae explained that requiring
delegated servicers to collect MNR provides a high level of confidence that each servicer
closing a delegated short sale will do so at a price that is superior to a real estate owned sale.
In turn, this helps to minimize credit losses to the Enterprise.

Fannie Mae determines MNR for each short sale transaction upon notification from its
delegated servicers that a short sale is anticipated. After calculating MNR, Fannie Mae
informs its servicers of their delegated authority and how much money they need to collect
from the sale. If the servicer determines that the projected net proceeds from a proposed sale
are less than the authorized MNR amount, the short sale transaction becomes non-delegated
and the servicer submits it to Fannie Mae to determine an acceptable price. After Fannie Mae
determines the price that it will accept for the property, it communicates this price to the
servicer and any additional pricing changes that may result from negotiations with the
prospective buyer. The authorized price for non-delegated short sales is almost always less
than MNR and requires approval from varying levels of authority at Fannie Mae, depending
upon the difference between the expected net proceeds from the sale and the non-delegated
pricing thresholds used by Fannie Mae.2 The larger the difference and credit loss to Fannie
Mae, the higher the level of approval required.




1
 MNR was derived through a process that is proprietary to Fannie Mae that utilizes broker price opinions
(BPO), appraisals, market data, and the results of Fannie Mae’s valuation analytics.
2
 In certain instances involving non-delegated short sales, Fannie Mae negotiated a price that resulted in net
proceeds exceeding MNR.




                                    OIG  AUD-2014-015  August 7, 2014                                         7
Remedies Available to Fannie Mae in the Event of Servicing Guide Violations

Fannie Mae rewards its servicers for closing short sales with an incentive fee ranging from
$750 to $2,500, depending on how many days the property had been delinquent as of the day
of the short sale. Prior to June 2012, servicers were paid incentive fees at a flat rate of $1,700
per short sale closed. Conversely, if Fannie Mae’s servicers fail to comply with their servicing
requirements, the guide allows Fannie Mae broad discretion to penalize servicers for non-
performance. While the guide does not address specific remedies for MNR violations by
servicers related to short sales, it provides for the application of interest penalties in situations
where servicers do not remit funds to Fannie Mae as required, such as untimely remittance of
loan payments.

Fannie Mae Identification of Short Sale Control Failures and Servicing Violations

Fannie Mae did not have adequate controls in place to confirm MNR compliance before 2014.
Reviews of short sales conducted by Fannie Mae confirmed that the net proceeds received
matched the expected net proceeds based on the final HUD-1, but did not focus on whether
net proceeds received were at least equal to MNR. Until January 2014, delegated cases could
be closed by the servicer without being reviewed by Fannie Mae to confirm that MNR
requirements were met. Accordingly, there was no assurance that servicers were acting within
their delegated authority.

Although Fannie Mae lacked controls to ensure compliance with its MNR requirement, it
monitored servicers for compliance with its short sale program. Fannie Mae’s top servicers
were subject to annual reviews known as Servicer Quality Reviews (SQRs) performed by
its National Servicing Organization (NSO). SQRs are conducted to test servicer compliance
with the Servicing Guide and Delegation of Authority through sample audits. Short sales
are included within the scope of most of these reviews and a full file review is completed
that includes a review for compliance with MNR. Fannie Mae stated that from a scope
perspective, at the end of 2013, less than 5% of short sales were able to be closed by servicers
as delegated short sales without Fannie Mae approval. Fannie Mae further explained that the
small percentage of delegated short sales was due to increases to MNR values based on strong
real estate sales. Delegated servicers had to obtain approval from Fannie Mae to close short
sales when projected net proceeds from prospective offers fell short of MNR. In turn, many
transactions became non-delegated.




                                OIG  AUD-2014-015  August 7, 2014                                     8
FINDING ...................................................................................

Fannie Mae’s Servicers Did Not Always Close Short Sales at the Authorized Price and
Fannie Mae’s Remediation Plan Does Not Hold Servicers Fully Accountable for the
Resulting Loss

From August 2010 through December 2013, Fannie Mae’s delegated servicers did not always
collect MNR, the price at which Fannie Mae authorized them to close short sales. As a result,
these servicers remitted proceeds that were less than the authorized amount, causing further
losses to the Enterprise. Fannie Mae also compiled a proposed remediation plan, however,
the plan does not fully account for resulting losses or impose remedies on servicers that
repeatedly violate Fannie Mae’s delegations of authority.

    Operational Incident Involving Delegated Short Sales

On or about January 13, 2014, a servicer contacted a Fannie Mae Real Estate Asset
Management (REAM) Sales Representative to request an extension on a short sale. The
REAM representative determined that the short sale was never submitted to Fannie Mae
for approval, despite the net proceeds not meeting MNR. Following this contact, REAM
conducted an investigation of short sales completed between January 1, 2013, and December
31, 2013, to determine if other delegated short sales did not meet MNR. On January 27, 2014,
Fannie Mae filed an internal operational incident report which disclosed that numerous
servicers approved short sales for cases considered to be delegated even though the servicers
did not meet the minimum threshold established by Fannie Mae for delegated authority. 3
Fannie Mae’s investigation determined that out of an initially identified $10 million in MNR
shortfall for short sales completed during 2013, $3.4 million would not have been approved
by Fannie Mae if properly submitted as non-delegated short sales. Fannie Mae, therefore,
estimated the loss to Fannie Mae at $3.4 million for 2013 only. REAM, who took ownership
of the short sale closing space beginning in January 2013, confirmed that $3.4 million should
have been subject to non-delegated review and approval by Fannie Mae.

This operational incident report identified the cause of this incident as “…delegated short
sales executed by servicers were not reviewed by the REAM Fulfillment Department to
ensure minimum net reserve was met. The root cause was Inadequate Process Design –

3
  Fannie Mae officials informed OIG that the servicer contact during January 2014 to request an extension
for a short sale triggered the filing of this operational incident report. Nonetheless, Fannie Mae was initially
put on notice that a delegated servicer had executed a short sale that did not meet the minimum acceptable
net proceeds following the completion of an SQR report in October 2012. FHFA was put on notice about the
operational incident in February 2014.




                                     OIG  AUD-2014-015  August 7, 2014                                           9
Procedures and Processes.” It also disclosed that the NSO Loss Mitigation Team was
conducting research for cases submitted prior to January 1, 2013, to determine whether the
operational incident also affected short sale transactions completed before REAM assumed
ownership of this process in January 2013.

    Fannie Mae’s Remediation Plan

Following completion of additional research, Fannie Mae compiled a memorandum dated
May 8, 2014, on the subject of “Remedy Recommendation for Minimum Net Reserve (MNR)
Shortages on Delegated Short Sales.” According to this remediation plan, Fannie Mae
identified 2,114 cases closed between August 20104 and December 2013 where MNR was
not met, and an additional 320 cases where no MNR value was provided at all. Through
interviews with Fannie Mae officials and short sale transactional data provided by the
Enterprise, OIG determined that Fannie Mae identified 4,883 transactions where servicers
closed short sales below their delegated authority dating from August 2010 to December
2013. However, Fannie Mae informed OIG that 2,449 of those transactions were excluded
from its remediation plan for one of three reasons: (1) because the short sale would have been
approvable if properly submitted as non-delegated, (2) the loan underlying the short sale had
already been remedied through a make whole agreement or repurchase, or (3) the transaction
had actually received Fannie Mae review prior to sale, but was not accurately represented in
their database as having received a non-delegated short sale review.

Fannie Mae identified 2,434 short sale transactions to include in the remediation plan
with indemnification amounts totaling $16,955,656 (MNR less net proceeds). However, it
incorporated four “recommended exclusions” utilizing a waterfall approach to exclude all
but 453 transactions from consideration to pursue an indemnification demand. See Figure 1
below, which lists each exclusion, the total number of short sales affected, and the total
indemnification amount for each exclusion category.




4
  In August 2010, a select group of servicers was granted delegated authority to approve and execute short
sales which met Fannie Mae’s eligibility requirements and MNR. This authority was extended in August 2012
with the issuance of Fannie Mae Servicing Guide Announcement SVC-2012-19.




                                  OIG  AUD-2014-015  August 7, 2014                                        10
               FIGURE 1. FANNIE MAE RECOMMENDED EXCLUSIONS TO REMEDIATION PLAN

                                                                                               Indemnification
                             Category                                      Loan Count             Amount
    Population Included in Fannie Mae’s Remediation Plan                         2,434              $16,955,656
    1. Harm Below Tolerable Threshold                                            (943)             ($1,165,930)
    2. Meets NSO Non-Delegated Criteria                                          (652)             ($3,377,674)
    3. Meets REAM Non-Delegated Criteria                                         (145)             ($1,593,073)
    4. Proceeds Exceed Estimated MNR                                             (241)                       ($0)
    Perceived Harm to Fannie Mae                                                   453              $10,818,979
Source: Fannie Mae, Remedy Recommendation for Minimum Net Reserve (MNR) Shortages on Delegated
Short Sales memorandum (May 8, 2014).

A description of each exclusion from Figure 1 included within Fannie Mae’s remediation plan
is as follows:

    1. Harm Amount Below Tolerable Threshold: Based on agreed upon thresholds
       established through FHFA’s Contract Harmonization Project.5

    2. Meets NSO Non-Delegated Criteria: Cases identified that closed prior to the transition
       to REAM that would have met the NSO’s loss mitigation approval requirements for
       non-delegated cases.

    3. Meets REAM Non-Delegated Criteria: Cases identified that closed after the transition
       of the process to REAM that would have met REAM’s requirements for consideration
       as non-delegated cases.

    4. Proceeds Exceed Estimated MNR: In instances where an MNR value was not obtained
       by the servicer, the Modeling and Analytics group was able to estimate with a high
       confidence level that MNR would have been provided at the time of closing based on
       BPO values. In the event net proceeds exceeded the estimated MNR amount, [Fannie
       Mae] logically assumes there was no loss.

After applying the four exclusions, Fannie Mae was left with a population of 453 transactions
in the “perceived harm” category. According to the remediation plan, it anticipates following
up with servicers by requesting confirmation from the impacted servicers of the values used


5
  In January 2012, FHFA established the Contract Harmonization Project to increase consistency in Enterprise
contracts. While Fannie Mae applied the threshold established under the Contract Harmonization Project to
its remediation plan, OIG noted that Fannie Mae’s own internal threshold for pursuing make whole agreements
for executing short sales at a price below servicer’s delegated authority was significantly less than the Contract
Harmonization threshold.




                                    OIG  AUD-2014-015  August 7, 2014                                              11
on the short sales in question. The responses and documentation received from the servicers
would then be used to determine if cases completed outside of their delegated authority
were to the material detriment of Fannie Mae. If material harm is confirmed, a formal
indemnification demand would be issued to the servicer for the amount of the variance
between MNR and net proceeds. The 453 transactions are concentrated among six servicers
as shown in Figure 2 below.

    FIGURE 2. CONCENTRATION OF MNR SHORTFALLS WITHIN THE 453 SHORT SALE TRANSACTIONS
                           WHERE FANNIE MAE PERCEIVED HARM
                                                                                        Concentration
                                                                Indemnification
                              Servicer                                                   Percentage
                                                                   Amount
                                                                                         [Rounded]
          Servicer 1                                                  $2,724,574                25.18%
          Servicer 2 6                                                $2,163,596                20.00%
          Servicer 3                                                  $1,252,145                11.57%
          Servicer 4                                                  $1,235,992                11.42%
          Servicer 5                                                    $687,087                 6.35%
          Servicer 6                                                    $602,012                 5.56%
          Servicers 7–30                                              $2,153,573                19.91%
          Total for All Servicers                                    $10,818,979              100.00%
Source: Fannie Mae, Remedy Recommendation for Minimum Net Reserve (MNR) Shortages on Delegated
Short Sales memorandum (May 8, 2014).

Fannie Mae informed OIG that although it anticipates no change to the structure of its
remediation plan or the various recommended exclusions, the remediation plan was going
to be revised and the number of identified short sale transactions would change.7 OIG is


6
  Servicer 2 was subject to an SQR report during August 2012. One of the findings in that report was this
servicer closed workout offers outside of the assigned delegated authority. Specifically, Fannie Mae’s review
of closed delegated short sales found instances where the net proceeds to Fannie Mae did not meet the
minimum acceptable net proceeds. As a result of this finding, the servicer agreed to provide updated
procedures and controls to ensure that all delegated short sales are approved to at least the minimum acceptable
net proceeds limit given by Fannie Mae; as well, the servicer agreed to certify the completion, implementation,
and training of staff on the procedures and process. Although Fannie Mae conducted SQR reviews of 39
servicers in 2013 and 40 servicers in 2012, this was the only SQR report identified by OIG that included
findings where a servicer closed short sales below the price authorized by Fannie Mae. Furthermore, 20 of the
30 servicers identified in Figure 2 were subject to an SQR review during 2013, and 21 of them were subject to
an SQR review during 2012, which suggests the SQR reports were not effective with respect to identifying
closed short sales that did not meet Fannie Mae’s authorized price.
7
  Fannie Mae officials explained that it was necessary to revise the plan as some short sale transactions
included within the 2,434 transactions in the remediation plan had been remedied either through a repurchase
or a make whole agreement and should be removed. Additionally, Fannie Mae informed OIG that all of the
short sale transactions were for three servicers. These transactions accounted for approximately 30% of the
transactions included in the remediation plan and would need to be manually reviewed before the plan could be



                                    OIG  AUD-2014-015  August 7, 2014                                            12
concerned that Fannie Mae has gone to some length to undercut the approval controls it
established for short sale transactions using MNR by in essence concluding that there is no
penalty for lack of compliance with established controls. The Enterprise’s approach shifts
responsibility from the servicer to Fannie Mae for ensuring compliance by not holding
servicers accountable.

      Fannie Mae Has the Authority to Issue an Indemnification Demand to Servicers that
      Incurred MNR Shortfalls and Penalize Them

While Fannie Mae’s actions to identify MNR shortages and develop a remediation plan are
positive steps, it is not aggressively pursuing available remedies to minimize its credit losses
and deter future servicing violations. Additionally, FHFA has not been actively involved in
oversight of the development of the remediation plan.

Although Fannie Mae identified 2,434 short sale transactions to include in the remediation
plan with MNR shortages totaling $16,955,656, it only plans to pursue indemnification from
servicers for 453 transactions, approximately 19 percent of the population. Additionally,
Fannie Mae does not intend to pursue any other remedies to penalize servicers, although
servicers were paid incentive fees to close short sale transactions and did so improperly
with many servicers being repeat offenders. Fannie Mae clearly has the authority to pursue
indemnification demands for each delegated short sale with an MNR shortfall. Fannie Mae’s
delegations of authority to its delegated servicers going back to 2010 provide that the net
proceeds received for each delegated short sale be greater than or equal to the Minimum
Acceptable Net Proceeds (MANP).8 Furthermore, the servicing guide allows broad discretion
to the Enterprise with respect to penalizing servicers for compliance failures. Nonetheless,
Fannie Mae’s current plan is to exclude the majority of the shortfalls from indemnification
where servicers failed to collect net proceeds that met MNR or request MNR from Fannie
Mae.

Further, FHFA has not been actively involved in oversight of the development of the
remediation plan or oversight of MNR requirements. The Enterprise informed FHFA of the
January 2014 operational incident; however, the Agency has not undertaken any follow-up
actions in response. FHFA was also not aware of the additional research that Fannie Mae
performed to assess the number of short sale transactions with MNR shortfalls, the results of
this research, or of Fannie Mae’s remediation plan and the recommended exclusions from the
plan. Additionally, although FHFA had performed a targeted examination of Fannie Mae’s

revised. OIG notes that while the revised plan does remove erroneous short sale transactions, it does not
change the overall methodology of the initial remediation plan.
8
    MANP is the equivalent of MNR and this terminology is used interchangeably.




                                    OIG  AUD-2014-015  August 7, 2014                                     13
collateral valuation methodology for short sales in late 2012 and early 2013, compliance with
Fannie Mae’s MNR requirement was not included within the scope of that examination.

    Fannie Mae Revised Its Remediation Plan

OIG received a revised remediation plan prior to final report issuance. The amount of short
sales covered under the updated remediation plan increased from 2,434 to 4,936 and total
potential shortfalls increased from $16,955,656 to $36,201,249. The potential harm category
increased from 453 to 594 short sales and the associated potential MNR shortfall increased
from $10,818,979 to $16,302,039. The amount of incentive fees paid to servicers for short
sales identified under this updated remediation plan that had unaddressed MNR shortfalls
totaled $4,428,950.9 While the plan appropriately removed transactions erroneously included
for remediation, the methodology of the plan remained substantially unchanged from the
initial version from which this report was completed.




9
  This figure includes incentive fees paid for loans in the “potential harm” category, as well as those excluded
by Fannie Mae for falling below a tolerable threshold or falling under either NSO or REAM non-delegated
criteria.




                                    OIG  AUD-2014-015  August 7, 2014                                            14
CONCLUSIONS ..........................................................................

Fannie Mae’s remediation plan may be improved by a thorough, independent review by its
internal audit group.10 FHFA should communicate a written supervisory expectation to Fannie
Mae requiring an independent internal audit of its completed remediation plan to assess the
reasonableness of the assumptions used to develop the plan, the sufficiency of the analysis
performed, and the other criteria included within OIG’s recommendation. FHFA should also
conduct a supervisory review of this assessment after it has been finalized by Fannie Mae’s
internal audit group and make any modifications to the remediation plan as deemed
appropriate and necessary to preserve and conserve the Enterprise’s assets.

Fannie Mae may also further mitigate losses from short sales through a comprehensive review
of its non-delegated short sales to determine whether servicers collected net proceeds that met
or exceeded the amount approved by Fannie Mae. FHFA should communicate a written
supervisory expectation to Fannie Mae requiring that the Enterprise perform this analysis and
develop a remediation plan if the analysis identifies shortfalls between the approved amount
and net proceeds for non-delegated short sales. This analysis and any resulting remediation
plan should also be reviewed by Fannie Mae’s internal audit group and be subject to a final
supervisory review by FHFA.

Following the issuance of its draft report, OIG learned that Fannie Mae’s internal audit group
has added a special review to its 2014 audit plan to evaluate the revised remediation plan and
plans to perform an assessment of MNR shortfalls and incentive fee recoupment. Such actions
are consistent with OIG’s recommendations and will assist FHFA in carrying out its
supervisory and conservator missions in this area.




10
   Fannie Mae’s internal audit group provides an objective assessment of the design and execution of its
internal control system, including its management systems, risk governance, and policies and procedures.
Internal audit activities are designed to provide reasonable assurance that resources are safeguarded; that
significant financial, managerial, and operating information is complete, accurate, and reliable; and that
employee actions comply with Fannie Mae policies and applicable laws and regulations.




                                    OIG  AUD-2014-015  August 7, 2014                                       15
RECOMMENDATIONS ...............................................................

OIG recommends that FHFA:

   1. Communicate a written supervisory expectation to Fannie Mae requiring that its
      business units perform a review of non-delegated short sale transactions to identify
      any transactions where the servicer submitted net proceeds that were less than the sale
      amount approved by Fannie Mae and draft a remediation plan, as appropriate.

   2. Communicate a written supervisory expectation to Fannie Mae requiring its internal
      audit group to review Fannie Mae’s plan to collect funds for delegated and non-
      delegated short sale transactions where the net proceeds received were less than the
      amounts authorized by Fannie Mae.

   3. Analyze Fannie Mae’s actions and remediation plans in response to recommendations
      1 and 2 to determine whether Fannie Mae has taken necessary steps to ensure that
      servicers are held accountable for servicing violations and credit losses are minimized.
      FHFA should also require modification by Fannie Mae of its remediation plans, as
      appropriate.




                             OIG  AUD-2014-015  August 7, 2014                                 16
OBJECTIVES, SCOPE, AND METHODOLOGY ...............................

The objective of this performance audit was to assess FHFA’s oversight of Fannie Mae’s
controls over the pricing of properties sold in short sales.

OIG conducted this performance audit from January 2014 through June 2014 in Washington,
D.C., at the headquarters of FHFA and Fannie Mae.

The scope of OIG’s audit focused on the effectiveness of FHFA’s oversight of Fannie Mae’s
controls to ensure that the Enterprise’s delegated servicers received net proceeds from closed
short sales that met Fannie Mae’s authorized price. For purposes of this audit, OIG did not
assess controls over computer-processed data.

OIG did not conduct transaction testing of non-delegated short sale transactions to ensure
short sales were closed as approved by Fannie Mae, however, OIG is recommending that
FHFA direct Fannie Mae to conduct such analysis based on OIG’s finding on delegated
transactions. Also, the OIG’s audit scope did not include a detailed review of Fannie Mae’s
short sale pricing and valuation methodologies due to FHFA’s recent exam work in that
area.To achieve the audit objective, OIG:

      Interviewed Fannie Mae officials responsible for the oversight of short sale pricing,
       including personnel from the Real Estate Asset Management team and the National
       Servicing Organization;

      Interviewed Fannie Mae internal audit officials to assess internal audit coverage of the
       pricing of short sale transactions;

      Consulted with FHFA staff from the Division of Enterprise Regulation about the
       Agency’s oversight, supervision, and guidance of short sales operations;

      Reviewed Fannie Mae’s delegations of authority and Servicing Guide for policies and
       procedures regarding short sales and other documentation concerning the pricing of
       short sale transactions; and

      Reviewed short sales between August 2010 and December 2013 that Fannie Mae
       identified had been closed below MNR and a preliminary remediation plan based upon
       Fannie Mae’s analysis of these transactions.

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:



                              OIG  AUD-2014-015  August 7, 2014                                  17
      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 its findings regarding FHFA’s oversight of Fannie
Mae’s controls over proceeds from short sales 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 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  AUD-2014-015  August 7, 2014                                 18
APPENDIX A .............................................................................

FHFA’s Comments on OIG’s Findings and Recommendations




                           OIG  AUD-2014-015  August 7, 2014                         19
OIG  AUD-2014-015  August 7, 2014   20
APPENDIX B..............................................................................

OIG’s Response to FHFA’s Comments

On July 29, 2014, FHFA provided comments to a draft of this report, agreeing with
OIG’s recommendations and identifying the specific actions it would take to address the
recommendations.

FHFA agreed with Recommendation 1 and its planned actions are responsive. FHFA will
communicate a written supervisory expectation that Fannie Mae perform a risk based
review of non-delegated short sales by October 15, 2014. This review should result in a
determination of whether there is a significant difference between sale amounts approved by
Fannie Mae for properties transferred in short sales and actual net proceeds received from
servicers. In the event of material shortfalls in actual net proceeds received, the review should
inform a risk-based remediation plan for the recovery of losses.

FHFA agreed with Recommendation 2. FHFA will, by October 15, 2014, communicate a
written supervisory expectation that Fannie Mae’s internal audit group review Fannie Mae’s
risk management relating to the conduct of short sales by servicers and communicate findings
to the business units. The review by internal audit should cover: (1) the adequacy of controls
for the short sale program for both delegated and non-delegated short sales; (2) recent or
proposed changes to the controls; and (3) any efforts to recover shortfalls in net proceeds from
delegated or non-delegated short sales.

FHFA agreed with Recommendation 3. FHFA will perform and document ongoing
monitoring by examiners to review the adequacy of Fannie Mae’s controls for delegated and
non-delegated short sales and internal audit coverage of those controls by July 31, 2015.

OIG intends to evaluate the results achieved by FHFA and Fannie Mae in the performance
of work related to the recommended FHFA supervisory expectations in the areas of: (1) the
amount Fannie Mae should be paid for the shortfalls in net proceeds on short sale
transactions; and (2) recoupment of incentive fees for each short sale transaction with a
shortfall. To the extent that monetary benefits result, OIG intends to report these benefits as
funds put to better use in its next semiannual report to Congress. As a result, OIG is reporting
that the amount of monetary benefits, if any, associated with Recommendations 1 and 2 as
“To Be Determined.”

OIG considers the planned actions sufficient to resolve the recommendations, which will
remain open until OIG determines that the agreed-upon corrective actions are completed and
responsive to the recommendations. We considered the Agency’s full response (attached as
Appendix A) along with technical comments in finalizing this report. Appendix C provides a

                              OIG  AUD-2014-015  August 7, 2014                                   21
summary of management’s comments on the recommendations and the status of agreed-upon
corrective actions.




                           OIG  AUD-2014-015  August 7, 2014                          22
APPENDIX C ..............................................................................

Summary of FHFA’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
Rec.              Corrective Action:            Completion   Monetary     Resolveda   Open or
No.               Taken or Planned                 Date      Benefits     Yes or No   Closedb
       FHFA will communicate in writing
       to Fannie Mae the supervisory
       expectation that Fannie Mae will
       perform a risk based review of non-
       delegated short sales. This review
       should result in a determination
       of whether there is a significant
       difference between sales amounts
                                                                To Be
1      approved by Fannie Mae for               10/15/2014                  Yes        Open
                                                             Determined
       properties transferred in short sales
       and actual net proceeds received
       from servicers with respect to the
       transferred properties. In the event
       of material shortfalls in actual net
       proceeds received, the review should
       complete a risk-based remediation
       plan for the recovery of losses.
       FHFA will communicate to Fannie
       Mae the supervisory expectation that
       Fannie Mae’s internal audit group
       will review Fannie Mae’s risk
       management relating to the conduct
       of short sales by servicers and
       communicate findings to the
       business units. The review by internal                   To Be
2                                               10/15/2014                  Yes        Open
       audit is to cover (1) the adequacy of                 Determined
       controls for the short sale program
       for both delegated and non-
       delegated short sales, (2) recent or
       proposed changes to controls, and
       (3) any efforts to recover short falls
       in net proceeds from delegated and
       non-delegated short sales.
       FHFA will perform and document
3      ongoing monitoring by examiners to       07/31/2015      $0          Yes        Open
       review the adequacy of Fannie Mae’s


                               OIG  AUD-2014-015  August 7, 2014                            23
                                                      Expected
Rec.              Corrective Action:                 Completion        Monetary        Resolveda        Open or
No.                Taken or Planned                     Date           Benefits        Yes or No        Closedb
        controls for delegated and non-
        delegated short sales and internal
        audit coverage of controls.
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-2014-015  August 7, 2014                                         24
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-2014-015  August 7, 2014                         25