oversight

Review of FHFA's Tracking and Rating of the 2013 Scorecard Objective for the New Representation and Warranty Framework Reveals Opportunities to Strengthen the Process

Published by the Federal Housing Finance Agency, Office of Inspector General on 2016-03-28.

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

          Federal Housing Finance Agency
              Office of Inspector General




  Review of FHFA’s Tracking and
   Rating of the 2013 Scorecard
Objective for the New Representation
 and Warranty Framework Reveals
  Opportunities to Strengthen the
               Process




 Audit Report  AUD-2016-002  March 28, 2016
                 Executive Summary
                 The Federal Housing Finance Agency (FHFA or the Agency) is responsible
                 for the supervision, regulation, and housing mission oversight of the Federal
                 National Mortgage Association (Fannie Mae) and the Federal Home Loan
                 Mortgage Corporation (Freddie Mac). Since 2008, FHFA also has been the
                 conservator of Fannie Mae and Freddie Mac (together, the Enterprises).
AUD-2016-002
                 During 2012, FHFA announced significant changes to the Enterprises’
March 28, 2016   representation and warranty framework. Historically, the Enterprises had
                 relied on the sellers’ representations and warranties when purchasing loans
                 from sellers. In the event of default of a purchased loan, the affected
                 Enterprise reviewed the loan file for possible breach by the seller of its
                 contractual representations and warranties. When a breach was identified, the
                 affected Enterprise could exercise its contractual rights to require the seller to
                 repurchase the loan, mitigating losses caused by underwriting defects. After
                 the housing market collapsed and loan defaults skyrocketed, the Enterprises
                 were placed into conservatorship. At the direction of FHFA, the Enterprises
                 reviewed defaulted loans for evidence of breach of sellers’ representations and
                 warranties and the Enterprises demanded repurchase of many such loans from
                 the lenders.

                 Sellers complained that the Enterprises’ open-ended ability to demand loan
                 repurchases was unfair and unpredictable, and caused them to tighten lending
                 standards beyond what the Enterprises required to protect themselves from
                 future exposure from loan repurchases. Concerned by the limitations on the
                 availability of mortgage credit, FHFA directed the Enterprises in 2012 to
                 develop and implement a new representations and warranties framework (new
                 Framework) to provide sellers with greater certainty about their potential
                 future repurchase exposure. That new Framework, which went into effect for
                 loans purchased after January 1, 2013, in many circumstances imposed a three-
                 year deadline after which the Enterprises could no longer demand repurchase
                 of defective loans from sellers of those loans.

                 FHFA issued its Strategic Plan for Enterprise Conservatorships (Strategic
                 Plan) in February 2012, which identified its strategic goals. Beginning in 2013
                 and for each year subsequently, FHFA has issued an annual Scorecard in
                 which it sets objectives for each of the three goals in its Strategic Plan and sets
                 specific targets for each objective. FHFA has a formal process to track and
                 rate Enterprise performance against the Scorecard on a quarterly basis and to
                 award an overall annual Scorecard performance for each Enterprise. This
                 annual rating is factored into Enterprise executive compensation for the
                 following year. Tracking Enterprise performance against the annual Scorecard
                 is a valuable internal control to keep Enterprise activities aligned with
                 conservatorship strategic goals and to keep Enterprise executives accountable
                 for the Enterprises’ performance.

                 FHFA’s 2013 Scorecard, issued on April 1, 2013, and revised on May 1, 2013
                 (2013 Scorecard), identified 11 measurable objectives with specific targets for
                 the Enterprises to work toward meeting FHFA’s strategic goals. One of those
                 11 objectives was implementation of the new Framework. That objective
AUD-2016-002     contained two quarterly targets for both Enterprises. The first target required
                 development of a plan to conduct up-front quality control reviews and the
March 28, 2016   second target required an assessment of the Enterprises’ execution of the new
                 model and use of tools to identify defective loans, and an assessment of the
                 effectiveness of the up-front quality control reviews.

                 In this audit, OIG reviewed the effectiveness of FHFA’s efforts to track and
                 rate Enterprise performance on this one objective. We found that FHFA’s
                 records of the tracking and rating process were imprecise and unclear. The
                 records contained internal inconsistencies and did not clearly reflect when
                 targets were modified or deferred, or what actions were required to meet the
                 target. We found that these records can create the misimpression that work
                 had been completed when, in fact, it had been modified or delayed. We also
                 found that the Agency did not consistently communicate guidance to the
                 Enterprises in writing. Because of the importance of FHFA’s Scorecard
                 tracking and rating process, we make several recommendations regarding
                 FHFA’s tracking and rating process to improve clarity and avoid confusion and
                 inconsistencies. FHFA accepted our recommendations and reported that it had
                 taken steps prior to the issuance of this report to address the recommendations
                 included in the report (see Appendix A).

                 This audit was conducted by Cassandra Ingram, Audit Manager, with support
                 from Moira T. Roberts, Special Counsel. We greatly appreciate the assistance
                 and input provided by FHFA and the Enterprises.

                 We distributed this report to Congress, the Office of Management and Budget,
                 and others, and posted it at www.fhfaoig.gov.




                 Stacey Nahrwold
                 Acting Deputy Inspector General for Audits
TABLE OF CONTENTS ................................................................
EXECUTIVE SUMMARY .............................................................................................................2

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

BACKGROUND .............................................................................................................................7
      Historically, the Enterprises Demanded that Sellers Repurchase Defaulted Loans
      Found in Breach of the Sellers’ Representations and Warranties, Regardless of when
      Default Occurred ......................................................................................................................7
      Uncertainty Over Future Exposure to Repurchase Demands Led Sellers to Impose
      Credit Overlays .........................................................................................................................8
      FHFA Directed the Enterprises to Adopt and Implement a New Representations and
      Warranties Framework in an Effort to Reduce Credit Overlays ..............................................9
      Implementation of the New Representation and Warranty Framework .................................10
      The 2013 Conservatorship Scorecard Included the New Framework as an Enterprise
      Objective .................................................................................................................................10

FACTS AND ANALYSIS.............................................................................................................12
      FHFA’s Scorecard Tracking and Rating Process ...................................................................12
      FHFA’s Tracking and Rating of Enterprise Performance for the New Framework
      Objective in the 2013 Scorecard .............................................................................................14
              Third Quarter Target: Provide a Plan for Enhancing Quality Control ..........................14
             Fourth Quarter Target: Assess the Execution of Enhanced Quality Control
             Reviews and Evaluate Effectiveness ..............................................................................15

FINDING .......................................................................................................................................19
      FHFA’s Records in Support of Its Quarterly and Year-End Ratings for the
      Representation and Warranty Objective in the 2013 Scorecard Are Imprecise and
      Inconsistent .............................................................................................................................19

CONCLUSIONS............................................................................................................................21

RECOMMENDATIONS ...............................................................................................................22

OBJECTIVE, SCOPE, AND METHODOLOGY .........................................................................23

APPENDIX A ................................................................................................................................25


                                            OIG  AUD-2016-002  March 28, 2016                                                                 4
     FHFA’s Comments on OIG’s Finding and Recommendations ..............................................25

ADDITIONAL INFORMATION AND COPIES .........................................................................27




                                 OIG  AUD-2016-002  March 28, 2016                                       5
ABBREVIATIONS .......................................................................

2013 Scorecard     FHFA’s Scorecard issued on April 1, 2013, and revised on May 1, 2013

DHMG               Division of Housing Mission and Goals

ECB                Executive Compensation Branch

Enterprises        Fannie Mae and Freddie Mac

Fannie Mae         Federal National Mortgage Association

FHFA or Agency     Federal Housing Finance Agency

Freddie Mac        Federal Home Loan Mortgage Corporation

New Framework      New Representation and Warranty Framework effective January 1, 2013

OHRP               Office of Housing and Regulatory Policy

OIG                Federal Housing Finance Agency, Office of Inspector General

Strategic Plan     FHFA’s Strategic Plan for Enterprise Conservatorships, February 2012




                         OIG  AUD-2016-002  March 28, 2016                              6
BACKGROUND ..........................................................................
FHFA is responsible for the supervision, regulation, and housing mission oversight of the
Enterprises and the Federal Home Loan Banks and their Office of Finance. As regulator,
FHFA’s mission is to ensure that these regulated entities operate in a safe and sound manner
so that they serve as a reliable source of liquidity and funding for housing finance and
community investment. Since 2008, FHFA also has acted as conservator of the Enterprises.

FHFA issued its Strategic Plan for the conservatorship in February 2012. This Plan set three
broad strategic goals for the conservatorship:

       Build a new infrastructure for the secondary mortgage market;

       Gradually contract the Enterprises’ dominant presence in the marketplace while
        simplifying and shrinking their operations; and

       Maintain foreclosure prevention activities and credit availability for new and
        refinanced mortgages.

Approximately seven months after adoption of its Strategic Plan, FHFA announced a new
initiative aimed at achieving the third strategic goal—maintaining foreclosure prevention
activities and credit availability for new and refinanced mortgages. In June 2012, FHFA
directed the Enterprises to launch a new Framework for conventional loans sold or delivered
on or after January 1, 2013.1 This new Framework significantly changed when the
Enterprises reviewed loans and the methodology they used to identify potentially defective
loans.

Historically, the Enterprises Demanded that Sellers Repurchase Defaulted Loans Found
in Breach of the Sellers’ Representations and Warranties, Regardless of when Default
Occurred

The Enterprises provide liquidity to the U.S. housing finance system by purchasing residential
mortgages and bundling the purchased loans into securities for which they guarantee principal
and interest. In guaranteeing the securities, the Enterprises assume the credit risk from
possible default of the underlying loans. To mitigate this risk, the Enterprises purchase loans

1
  We are publishing today a memorandum closing a survey involving FHFA oversight of conservatorship
directives. In that memorandum, we note that FHFA relied on the Enterprises to self-report issues with
implementation and compliance with conservatorship directives and that the reports the Agency received from
the Enterprises were of limited value because of inaccuracies and incomplete information. See “FHFA’s
Oversight of the Enterprises’ Implementation of and Compliance with Conservatorship Directives during an
18-Month Period from January 2013 through June 2014.”



                                  OIG  AUD-2016-002  March 28, 2016                                         7
only from sellers that make specific contractual representations and warranties that their
mortgages meet the specific underwriting standards set forth in the Enterprises’ selling
guidelines and agreements.

Historically, the Enterprises performed minimal
quality control reviews on the loans at the time of           Representations and Warranties:
purchase. In the event of default of a purchased loan,        A mortgage lender’s assurances
the affected Enterprise reviewed whether that loan            that the mortgages it sells to the
                                                              Enterprises comply with certain
complied with the seller’s representations and
                                                              standards, such as underwriting
warranties in the lender contract. When an                    and documentation standards.
Enterprise found that a defaulted loan breached               Violations of a representation or
these representations and warranties in any way,              warranty entitles the Enterprise
the Enterprise could exercise its contractual right to        that purchased a loan to pursue
demand that the seller repurchase the non-compliant           certain remedies, including having
loan at any time during the life of the loan, even if         the lender buy back, or
                                                              repurchase, the loan.
the loan defaulted years after it was made. (Many,
but not all, repurchase demands were made for loans           Lender Contract: The lender’s
that defaulted within three years of purchase by an           obligations to comply with the
                                                              Enterprises’ agreements (i.e.,
Enterprise.) This right to demand repurchase of
                                                              Selling Guides) in their entirety.
defaulted loans that did not comply with any
representation and warranty in the lender contract            Repurchase: A remedy in lender
mitigated the risk of losses to the Enterprises from          contracts under which the lender
defaulted loans.                                              must buy back or otherwise make
                                                              the Enterprise whole for a
After the housing market collapsed and loan defaults          mortgage it previously sold to the
                                                              Enterprises.
skyrocketed, the Enterprises were placed into
conservatorship in September 2008 by FHFA and
required a total investment of $187.5 billion in taxpayer funds to remain viable. At the
direction of FHFA, the Enterprises aggressively exercised their right to demand repurchases
from sellers of defaulted loans in breach of lenders’ representations and warranties.

Uncertainty Over Future Exposure to Repurchase Demands Led Sellers to Impose
Credit Overlays

As the number of Enterprise mortgage repurchase
                                                              Credit Overlay: Additional borrower
demands increased steadily through 2010 and 2011, it
                                                              qualification requirements that are
was reported that several large financial institutions        more stringent than the minimum
increased their reserves significantly so they would          requirements set by the Enterprises.
have sufficient funds to repurchase defaulted loans.          Overlays may reduce the ability of
Numerous sellers claimed that the Enterprises’                some borrowers to obtain loans.
repurchase demands were unreasonable because the


                              OIG  AUD-2016-002  March 28, 2016                                    8
defaults occurred years after the mortgages were originated and were unrelated to breaches of
the sellers’ representations and warranties. Claiming that they lacked certainty about the size
of their future risk exposure for repurchases under the existing representation and warranty
framework, sellers imposed more stringent loan criteria than those required by the Enterprises
in order to reduce the risks of future defaults and repurchase demands. In May 2012, FHFA
officials recognized that sellers had “curbed their appetite” for new risk through credit
overlays,2 ultimately affecting the liquidity and availability of mortgage credit.

FHFA Directed the Enterprises to Adopt and Implement a New Representations and
Warranties Framework in an Effort to Reduce Credit Overlays

In June 2012, FHFA instructed the Enterprises to implement an agreed-upon representation
and warranty framework in their seller-servicer contracts. In September 2012, FHFA Acting
Director DeMarco publicly announced the new framework for conventional loans sold or
delivered on or after January 1, 2013. He explained that the “objective of the new framework
is to clarify lenders’ repurchase exposure and liability on future deliveries. Under this
framework, lenders will be relieved of certain repurchase obligations for loans that meet
specific payment requirements.”3 For this new Framework to be effective, FHFA recognized
that quality control reviews would need to be improved and would need to occur soon after
purchase of the loans. In announcing this new Framework, Acting Director DeMarco stated
that “the focus of the Enterprises’ quality control reviews will be shifted earlier in the loan
process, generally between 30 to 120 days after loan purchase.”4 In his view, “better quality
loan originations and underwriting, along with consistent quality control, will help maintain
liquidity in the mortgage market while protecting the Enterprises from loans not underwritten
to prescribed standards.”5

In its 2012 Report to Congress, published in June 2013, FHFA reported that it had directed
the Enterprises to adopt the new Framework in order to provide more certainty to lenders and
to improve the Enterprises’ credit risk management practices. FHFA recognized that the
success of the new Framework turned on the Enterprises’ ability to conduct quality control
reviews earlier in the process and, as part of those reviews, evaluate loan files on a more

2
 FHFA OHRP, Concept Approval Request [for Representations and Warranties Prospective New
Framework], at 1 (May 25, 2012).
3
 Remarks as Delivered by Edward J. DeMarco, FHFA Acting Director, The Conservatorships of Fannie Mae
and Freddie Mac: An Update on Current and Future Operations, at 5 (Sept. 10, 2012), online at
www.fhfa.gov/Media/PublicAffairs/Pages/Remarks-as-Delivered-Edward-J-DeMarco-Acting-Director-FHFA-
American-Mortgage-Conference.aspx.
4
    Id.
5
    Id.




                                OIG  AUD-2016-002  March 28, 2016                                    9
comprehensive basis to identify significant deficiencies. FHFA did not quantify the
additional credit risk associated with the new Framework.6

Implementation of the New Representation and Warranty Framework

On January 1, 2013, the Enterprises launched the new Framework for loans purchased on or
after that date. Under the new Framework, the time period for repurchase demands for one
kind of loan concludes one year after purchase by the Enterprise, assuming an acceptable
12-month payment history, and subject to certain exceptions. For most other loans,
repurchase was unavailable upon completion of 36 months of acceptable payment history,
also subject to certain exceptions.7 Because the new Framework limited the time periods
in which the Enterprises could make repurchase demands, it compelled the Enterprises to
conduct quality control reviews soon after the loans were delivered to the Enterprises.

The 2013 Conservatorship Scorecard Included the New Framework as an Enterprise Objective

FHFA issues annual guidance to the Enterprises about specific actions expected from them to
achieve the goals of the Strategic Plan for the conservatorships. The annual guidance, called
the Scorecard, sets objectives for each of the three goals in the plan and specific targets for
each objective. The targets are actions or deliverables with due dates and provide metrics
used by FHFA to rate each Enterprise’s performance to determine whether it has achieved the
objective during the year. The Enterprise’s annual performance rating factors into Enterprise
executive compensation levels for the following year.




6
 OIG recommended in a 2014 audit that FHFA perform an analysis of the risks and benefits of the new
Framework. FHFA disagreed with the recommendation and declined to do the analysis. See OIG, FHFA’s
Representation and Warranty Framework, at 28, 32-37 (Sept. 17, 2014) (AUD-2014-016).
7
 Certain loan defects, such as those involving fraud, were exempt from repurchase deadlines. Beginning in
mid-2014, the time period for making a repurchase demand expired immediately after a loan successfully
passed an Enterprise’s quality control review. See FHFA, A Progress Report on the Implementation of
FHFA’s Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac, at 4-5 (Mar. 16, 2015).



                                  OIG  AUD-2016-002  March 28, 2016                                       10
The 2013 Scorecard listed 11 objectives for the Enterprises in 2013. One objective addressed
implementation of the new Framework and included two specific targets, as follows:

  2013 New Framework          First Quarter   Second Quarter     Third Quarter    Fourth Quarter
         Objective                Target          Target             Target           Target
 Enhance Post Delivery       None             None             Provide a plan    Assess GSE
 Quality Control—                                              to FHFA that      execution of
 Enhance post-delivery                                         outlines how we   the new model,
 quality control practices                                     will meet the     including up-
 and transparency                                              objective.        front quality
 associated with new                                                             control reviews
 representation and                                                              and use of tools
 warranty framework                                                              to identify
                                                                                 defective loans.
                                                                                 Evaluate
                                                                                 effectiveness.


We conducted this audit to assess FHFA’s tracking and rating of the Enterprises’ performance
under this Scorecard objective.




                               OIG  AUD-2016-002  March 28, 2016                              11
FACTS AND ANALYSIS ...............................................................

FHFA’s Scorecard Tracking and Rating Process

FHFA’s annual Scorecard sets objectives for each of the three goals in FHFA’s Strategic Plan
and sets specific targets for each objective. FHFA tracks Enterprise performance against the
Scorecard and gives each Enterprise an annual performance rating score, which becomes a
factor in setting compensation levels for Enterprise executives.

FHFA’s Executive Compensation Branch (ECB) and Office of Strategic Initiatives manage
FHFA’s Scorecard tracking and rating process. The process is set out in an internal
procedures document, augmented by written instructions from ECB’s manager of Executive
Compensation. FHFA’s procedure to track and rate Enterprise performance against the
Scorecard includes the following steps:

      Quarterly Tracking on Rating Sheets

       Every objective in the annual Scorecard is assigned to a “Project Lead” in a specific
       FHFA office or division who is charged with responsibility for tracking Enterprise
       performance against the targets of that objective. Each objective and its targets are
       identified on an FHFA rating sheet for each Enterprise. At the end of every quarter,
       each Enterprise assesses its performance against that quarter’s target(s), using the
       standard rating terms “Complete,” “On Schedule,” “Off Track,” “Ahead of Schedule,”
       or “At Risk,” and enters its self-rating and any further comments on the rating sheet.
       The Project Lead reviews the entries of the Enterprises and enters his or her own
       quarterly rating and comments.

       FHFA’s rating sheet template defines the standard rating terms. It states:

              [U]se the following ratings to describe progress toward quarterly
              metrics:

                  o OS – “On Schedule” – Met quarterly milestones and on
                    schedule to meet the annual goal.

                  o OT – “Off Track” – Did not meet quarterly milestones, but
                    will meet the annual goal.

                  o AoS – “Ahead of Schedule” – Met quarterly milestones,
                    began working next quarter milestones, and will meet the
                    annual goal.



                             OIG  AUD-2016-002  March 28, 2016                                12
               o At Risk – Expect that the annual goal will not be met.

                          If assessment is considered at risk, provide an
                           addendum explaining the factors contributing to the
                           metric not being met and steps to alleviate the risk.

               o Complete – Enterprise has completed the measure.

    [FHFA] Quarterly Scorecard Assessment Instructions, Aug. 2, 2013 (emphasis in
    original).

    If an Enterprise misses a target, the Project Lead is tasked with establishing a revised
    target date and a process for tracking Enterprise performance against that date. As
    needed, the Project Lead confers with each Enterprise during the year to assess its
    progress against the Scorecard.

    At year-end, the Enterprises may submit self-assessments for the entire year, in
    addition to their fourth-quarter rating sheet entries. After reviewing the Enterprises’
    rating sheet entries and other submissions, the Project Lead enters final ratings and
    comments on the rating sheets.

   Senior Level Review and Year-End Analysis Memo

    Senior officials in the same office or division as the Project Lead are responsible for
    submitting a year-end written analysis of Enterprise performance in meeting the
    specified objective identified in the Scorecard guidance. Using the rating sheets
    completed by the Enterprises and Project Lead, these officials compile a written
    narrative and analysis of Enterprise performance on the objective to which the relevant
    rating sheet is attached. The officials send the year-end analysis and attachments to
    ECB.

   ECB Review, Summary, and Recommendation

    ECB receives and reviews a year-end analysis of Enterprise performance for every
    Scorecard objective. After its review and discussions as needed with the drafting
    offices, ECB proposes numerical ratings for each Enterprise—a rating on each
    objective. ECB prepares a summary chart of ratings for the Enterprises and forwards
    it to the FHFA Director, along with all of the year-end written analysis memos and
    ratings sheets.




                           OIG  AUD-2016-002  March 28, 2016                                 13
      Final Scorecard Rating Submission by the FHFA Director

       As needed, the Director meets with ECB and other FHFA officials to discuss the ECB
       summary memorandum and attached material, including the proposed ratings. The
       FHFA Director reviews and submits the final Scorecard rating to each Enterprise.

FHFA’s Tracking and Rating of Enterprise Performance for the New Framework
Objective in the 2013 Scorecard

FHFA’s Division of Housing Mission and Goals (DHMG), Office of Housing and Regulatory
Policy (OHRP), was charged with responsibility for tracking and rating the Enterprises’
performance against the new Framework objective in the 2013 Scorecard Guidance.
DHMG’s ratings sheets (one for each Enterprise) contain ratings and comments for each
quarter containing a target.

   Third Quarter Target: Provide a Plan for Enhancing Quality Control

Freddie Mac. Freddie Mac rated its performance for the third quarter as “On Schedule.” It
explained that it had presented a plan to FHFA in August 2013 and would continue to update
the plan as it continued to implement the new Framework. The Project Lead concurred and
rated Freddie’s Mac’s performance as “On Schedule.”

Fannie Mae. Fannie Mae rated its own performance for the third quarter as “Complete”,
reporting that it submitted to FHFA a comprehensive plan to meet the objective on July 3,
2013. The Project Lead entered “Disagree; not complete” on the rating sheet. In rating sheet
comments, the lead wrote that Fannie Mae had submitted a PowerPoint presentation and an
attached spreadsheet, but that “the project continues at this stage.” The Project Lead went
on to request that Fannie Mae submit a “comprehensive project plan,” if available, “that
provides in narrative form the scope of the overall project plan, describes all planned activities
and deliverables, etc.” Notwithstanding these written entries, the Project Lead rated Fannie
Mae’s third quarter performance as “On Schedule,” without any explanation. The rating sheet
instructions state that the rating “On Schedule” means that the Enterprise has met quarterly
milestones, and the rating “Off Track” should be used when quarterly milestones are missed.

The reason for the inconsistency between the Project Lead’s comments and the Project Lead’s
rating cannot be determined from the Scorecard rating and tracking records. During this
audit, DHMG reported to us that Fannie Mae met the third quarter 2013 target at some point
in time because the totality of its submissions constituted an adequate plan. DHMG produced
two Fannie Mae Power Point presentations, from August and November 2013, which updated
the July 2013 presentation figures on sampling reports and reviews issued in 2013. Because
the third quarter rating sheet entries were undated, it is possible that the “On Schedule” rating



                              OIG  AUD-2016-002  March 28, 2016                                    14
was entered sometime later, after Fannie Mae had submitted an adequate plan, but on its face
the document is inconsistent in that it claims that the status is both “not complete” yet “On
Schedule.”

    Fourth Quarter Target: Assess the Execution of Enhanced Quality Control Reviews
    and Evaluate Effectiveness

According to FHFA, the Agency informed both Enterprises in November 2013 what would be
required of them for a fourth quarter deliverable.8 FHFA told us that the Agency delivered
this guidance in writing to Fannie Mae and in phone conversations with Freddie Mac
personnel.

In a November 2013 email to Fannie Mae, DHMG provided guidance on what FHFA
expected from it to satisfy the fourth quarter target. The email began by repeating the initial
Scorecard target:

        [P]lease assess your execution of the new model, including upfront quality
        control reviews and use of tools to identify defective loans, and evaluate
        effectiveness.

The email then added additional guidance:

        What we would like to see is a summary narrative report that discusses the
        extent to which the objectives were met for this scorecard item, as well as
        the factors that hindered and facilitated in meeting them. We’d like to see
        impacts, key findings and how they will inform future changes or
        modifications to your quality control practices and transparency associated
        with the new framework.

During this audit, FHFA stated that this guidance set the expectations of what would be
required of the Enterprises. Under this guidance, the Enterprises were required to give a
narrative report on what work had been done toward meeting the target, including hindering
and facilitating factors, impacts, key findings, and implications for future changes to quality
control practices. However, neither the rating sheets nor the 2013 Scorecard Guidance
reflects any modification of the fourth quarter target.

Freddie Mac. Freddie Mac rated its fourth quarter performance as “Complete,” and described
its efforts to implement the new Framework, including improvements to its quality control
reviews and tools. Freddie Mac submitted a separate year-end self-assessment memo in

8
 As discussed further below, a later FHFA document states that quality control effectiveness could not yet be
determined in 2013 due to insufficient data.



                                   OIG  AUD-2016-002  March 28, 2016                                          15
which it provided greater detail about its implementation activities. The memo summarized
its efforts to put into place up-front quality control reviews for the new Framework, its tools
to identify defective loans, lessons learned, and implications for further implementation. This
memo also discussed Freddie Mac’s efforts to update existing quality control practices and
principles, develop marketing tactics to support the Framework execution activities, update
systems, and monitor loan performance. The memo reported that Freddie Mac’s
implementation activities, including loan performance monitoring, was ongoing. The Project
Lead rated Freddie Mac’s fourth quarter performance as “Complete” and supported the rating
with broad statements about attitude and effort.

The Agency reported to us that it determined that Freddie Mac met its fourth quarter target
from information provided by Freddie Mac in its periodic status reports, and that the
Enterprise provided summaries of the evaluations it had been able to conduct with the limited
data available. However, in reviewing the Enterprise submission, it is difficult to identify
information that could be construed as a meaningful assessment of the effectiveness of the
new quality control reviews.

Fannie Mae. Fannie Mae rated its fourth quarter performance as “Complete” and supported
that rating by referring to a year-end self-assessment memo to FHFA in December 2013. The
memo summarized its efforts to put into place up-front quality control reviews for the new
Framework, its tools to identify defective loans, lessons learned, and implications for further
implementation. This memo discussed Fannie Mae’s efforts to assess up-front quality control
effectiveness and stated that this assessment was ongoing. The Project Lead rated Fannie
Mae’s performance for this quarter as “Complete,” and supported the rating with the same
broad statements about attitude and effort, without specifically addressing the elements of the
target. The Project Lead reported:

       [Fannie Mae/Freddie Mac] successfully completed the 2013 Scorecard
       objectives related to the implementation of the new Representation and
       Warranty framework.

       [Fannie Mae/Freddie Mac] staff was engaged in and devoted significant
       resources to implementing the new Representation and Warranty framework
       and enhancing their respective quality control practices and tools to support it.

Although both Fannie Mae and Freddie Mac reported that their assessments were ongoing and
the Agency reported that there was insufficient data available at the time, the 2013 Scorecard
rating records show no action to establish a revised target date for the original objective




                             OIG  AUD-2016-002  March 28, 2016                                  16
requirements and a means for tracking Enterprise performance against a revised date.9 We
note that the 2015 Scorecard Guidance, issued on March 31, 2015, instructs the Enterprises to
“[b]egin an analysis of the effectiveness of the current quality control process” during the first
quarter.

       Senior Level Review and Year-End Analysis Memo

DHMG prepared a 2013 year-end analysis memo discussing both Enterprises’ performances
on the new Framework objective in the Scorecard. That memo rated the performance of
each Enterprise as “Complete” and described each Enterprise’s relevant activities and
achievements. In language that echoed the Project Lead’s comments, the year-end memo
reported:

        Fannie Mae and Freddie Mac were engaged in and devoted significant
        resources to implementing the new Representation and Warranty framework
        and enhancing their respective quality control practices and tools to support it.

This year-end analysis memo, which attached the completed rating sheets, did not explain the
inconsistency between the Project Lead’s comments and the rating for Fannie Mae’s third
quarter performance. For the fourth quarter target, the memo recognized that quality control
effectiveness could not yet be determined for either Enterprise and attributed the delay to
insufficient data – which is inconsistent with the fourth quarter stated target of assessing the
effectiveness of the execution of the new model, including up-front quality control reviews.

       ECB Review, Summary, and Recommendation

ECB received a year-end memo for each of the eleven objectives in the 2013 Scorecard,
including the DHMG memo for the new Framework objective, and developed its overall
rating recommendation for the 2013 Scorecard and ratings for each of the Scorecard’s 11
objectives. For the new Framework objective, ECB concluded that the third and fourth
quarter ratings for each Enterprise were “Complete.” ECB’s comments on the two targets
were high-level and brief: “Both achieved. Good feedback for [Enterprise].”

ECB sent its rating recommendation to the Director on January 24, 2014, with a cover memo
in which it reported that its scoring was “based not only on ultimate accomplishment of
results but cooperation, relative contribution, and collaboration with the board, FHFA, the
other Enterprise, and market participants, as appropriate to the particular measure.” Attached
to ECB’s recommendations memo were supporting materials, including the year-end analysis
9
  ECB’s guidance to FHFA states, “[f]or objectives assessed as incomplete, Project Leads must describe how
and when the Enterprises will meet the objectives and the process for tracking progress.” However, the fourth
quarter target was deemed “Complete” and DHMG thus apparently did not conduct the procedures to ensure
that “incomplete” objectives are met and tracked in the future.



                                   OIG  AUD-2016-002  March 28, 2016                                          17
memo prepared by DHMG and a summary table showing year-end ratings by both the FHFA
offices and the Enterprises against each objective.

At the time of ECB’s review, the fourth quarter target for FHFA’s 2013 Scorecard continued
to state that the fourth quarter target required the Enterprises to assess its execution of up-
front quality control reviews and tools to identify defective loans, and evaluate effectiveness.
Nothing in ECB’s cover memo or summary chart reflected that DHMG had revised or
rescheduled a component of the representations and warranties objective.




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FINDING ...................................................................................

       FHFA’s Records in Support of Its Quarterly and Year-End Ratings for the
       Representation and Warranty Objective in the 2013 Scorecard Are Imprecise
       and Inconsistent

One of the 11 objectives in FHFA’s 2013 Scorecard was implementation of the new
Framework. Pursuant to established FHFA procedure, each Enterprise assessed its
performance in meeting the quarterly targets for that objective, as did the assigned
Project Lead, and the Enterprises and the Project Lead awarded a quarterly rating for that
performance. We found that one third-quarter rating assigned by the Project Lead for one of
the Enterprises was inconsistent with the Project Lead’s written performance assessment. The
written comments describe the Enterprise’s performance as “not complete” yet the Enterprise
performance was rated as “On Schedule,” indicating it had met the milestones for the quarter.

In addition, we found that the Scorecard target defined in the tracking and rating records was
inconsistent with other documentation indicating that the target could not be met at that time
due to insufficient data. The Enterprises’ performance for that quarter was rated “Complete.”
FHFA told OIG that DHMG’s subsequent guidance to the Enterprises set the expectations
for a summary narrative and the guidance did not set specific requirements to include data
analysis or metrics. According to the 2013 Scorecard guidance, the fourth quarter target
requires the Enterprises to assess the execution of their up-front quality control reviews and
use of tools to identify defective loans and evaluate effectiveness. We found that FHFA did
not revise the original 2013 Scorecard document to reflect that the Enterprises were unable
to assess the effectiveness of their quality control reviews because of insufficient data. The
Scorecard did not state that the target had been suspended or modified. Instead, the quarterly
rating sheet declared that both Enterprises completed the original target of:

       Assess[ing] GSE execution of new model, including up-front quality control reviews
       and use of tools to identify defective loans. Evaluat[ing] effectiveness.

Moreover, FHFA was not consistent in providing written guidance to the Enterprises, alerting
them of the expectations for the fourth quarter target. FHFA explained to OIG that the
Agency provided additional guidance on the fourth quarter target near the end of the quarter.
DHMG sent an email to one Enterprise and conducted oral discussions with the other
Enterprise. Because DHMG did not provide guidance in writing, we are unable to confirm
whether DHMG provided consistent guidance to both Enterprises.

In this audit, we identified internal inconsistencies in Agency documentation regarding the
Scorecard ratings and requirements and found that they did not clearly reflect when targets


                             OIG  AUD-2016-002  March 28, 2016                                 19
were modified or deferred. These inconsistencies and gaps, if not confined to this one
instance, have the potential to create the misimpression that Scorecard objectives have been
met when, in fact, they have been modified or delayed by staff.




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CONCLUSIONS ..........................................................................

FHFA issued its Strategic Plan in 2012 for the Enterprises. Beginning in 2013 and for each
year subsequently, FHFA has issued an annual Scorecard in which it sets objectives for each
goal in its Strategic Plan and sets specific targets for each objective. FHFA has a formal
process to track and rate Enterprise performance against the Scorecard on a quarterly basis
and to award an overall annual Scorecard performance for each Enterprise. This annual
rating is factored into Enterprise executive compensation for the following year. Tracking
Enterprise performance against each Scorecard is a valuable internal control to keep
Enterprise activities aligned with conservatorship strategic goals and to keep Enterprise
executives accountable for Enterprise performance.

During 2012, FHFA announced significant changes to the Enterprises’ representation and
warranty framework. Historically, the Enterprises relied on the sellers’ representations and
warranties when purchasing loans from sellers. In the event of default of a purchased loan,
the affected Enterprise reviewed the loan file for possible breach by the seller of its
contractual representations and warranties and could exercise its contractual rights to require
the seller to repurchase the loan upon a breach of a representation or warranty. In the wake
of the collapse of the housing market and soaring loan defaults, Enterprise repurchase
demands on sellers mounted. In response, sellers tightened lending standards beyond what
the Enterprises required to protect themselves from future uncertain exposure from loan
repurchase demands. In an effort to ease these restrictions on the availability of mortgage
credit, FHFA directed the Enterprises in 2012 to develop and implement a new Framework.
That new Framework, which went into effect for loans purchased after January 1, 2013, in
many circumstances imposed a three-year deadline after which the Enterprises could no
longer demand repurchase of defective loans from sellers of those loans. One objective in
FHFA’s 2013 Scorecard was implementation of the new Framework.

In this audit, we reviewed FHFA’s efforts to track and rate Enterprise performance on this
one objective in the 2013 Scorecard. We found that the fourth quarter target – deemed
“Complete” by the Agency – was inconsistent with other documentation indicating that the
deliverables for the target had been revised and that the original target could not be met due to
insufficient data. We also found that the Agency did not always communicate its expectations
to the Enterprises in writing. Because of the importance of FHFA’s Scorecard tracking and
rating process, we recommend enhancements to require greater clarity and minimize the risk
of misimpressions.




                              OIG  AUD-2016-002  March 28, 2016                                   21
RECOMMENDATIONS ...............................................................

OIG recommends that FHFA:

   1. Establish standards requiring that modifications or suspensions of Scorecard targets
      must be documented in writing;

   2. Require that FHFA comments and ratings on quarterly rating sheets be dated; and

   3. Establish standards to address missed or partially missed quarterly targets, including
      requiring that every quarterly rating sheet record when any target was missed and the
      reset target date.

On March 2, 2016, FHFA provided comments to a draft of this report, agreeing with all
recommendations and identifying FHFA actions which it believes have addressed each
recommendation. OIG has not yet assessed the Agency’s actions and will hold open its
recommendations until it determines that the corrective actions reported by FHFA are
completed and responsive to the recommendations.




                            OIG  AUD-2016-002  March 28, 2016                                22
OBJECTIVE, SCOPE, AND METHODOLOGY .................................
The objective of this performance audit was to assess FHFA’s oversight of the Enterprises’
implementation of the new representation and warranty framework through the conservator’s
Scorecard tracking system. Specifically, we assessed FHFA’s tracking and reporting of the
Enterprises’ performance against the 2013 Scorecard targets related to implementation of the
new Framework.

OIG conducted this performance audit from April 2015 through November 2015. OIG
conducted this audit in Washington, D.C. at FHFA and Fannie Mae headquarters, and in
McLean, VA at Freddie Mac headquarters.

The scope of OIG’s audit involved FHFA’s process for, and record of, tracking and rating
the Enterprises’ targeted deliverables under the 2013 Scorecard objective relating to the new
Framework. For purposes of this audit, OIG did not assess controls over computer-processed
data. To achieve the audit objective, OIG:

      Reviewed FHFA’s directives, guidelines, announcements, Scorecards, analyses, and
       other internal and external communications and documents concerning the new
       Framework that became effective in January 2013;

      Interviewed some of the FHFA officials responsible for tracking Enterprise
       performance against the 2013 Scorecard new Framework deliverables, for giving
       guidance to the Enterprises on those deliverables, for rating Enterprise performance on
       those deliverables, and for reporting Enterprise Scorecard performance and ratings to
       the conservator;

      Interviewed some of the Fannie Mae and Freddie Mac officials responsible for
       implementing changes in their quality control processes to comply with the new
       Framework; and

      Reviewed Enterprise guidelines, announcements, annual reports, analyses, internal and
       external reports, and documents associated with their new Framework quality control
       processes.

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

      Effectiveness and efficiency of operations;

      Reliability of financial reporting; and


                              OIG  AUD-2016-002  March 28, 2016                                  23
      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
evaluating, reporting, and monitoring program performance.

OIG conducted this performance audit in accordance with Generally Accepted Government
Auditing Standards. Those standards require that audits be planned and performed to obtain
sufficient, appropriate evidence to provide a reasonable basis for OIG’s findings and
conclusions based on the audit objective. OIG believes that the evidence obtained provides
a reasonable basis for the findings and conclusions included herein, based on the audit
objective.




                             OIG  AUD-2016-002  March 28, 2016                             24
APPENDIX A .............................................................................

FHFA’s Comments on OIG’s Finding and Recommendations




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OIG  AUD-2016-002  March 28, 2016   26
ADDITIONAL INFORMATION AND COPIES .................................

For additional copies of this report:

      Call: 202-730-0880

      Fax: 202-318-0239

      Visit: www.fhfaoig.gov



To report 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 Investigations – Hotline
                400 Seventh Street SW
                Washington, DC 20219




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