oversight

FHFA Completed its Planned Procedures for a 2016 Representation and Warranty Framework Targeted Examination at Freddie Mac, but the Supporting Workpapers Did Not Sufficiently Document the Examination Work

Published by the Federal Housing Finance Agency, Office of Inspector General on 2018-03-13.

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

                             REDACTED

                     Federal Housing Finance Agency
                         Office of Inspector General



FHFA Completed its Planned Procedures
for a 2016 Representation and Warranty
  Framework Targeted Examination at
              Freddie Mac,
     but the Supporting Workpapers
   Did Not Sufficiently Document the
           Examination Work




 This report contains redactions of information that is privileged or confidential.


      Audit Report • AUD-2018-006 • March 13, 2018
                 Executive Summary
                 The Federal National Mortgage Association (Fannie Mae) and the Federal
                 Home Loan Mortgage Corporation (Freddie Mac) (together, the Enterprises)
                 provide liquidity to the U.S. housing finance system by supporting the
                 secondary mortgage market. The Enterprises purchase residential mortgages
                 from lenders and either hold these mortgages in their portfolios or bundle the
AUD-2018-006     purchased mortgages into securities for which they guarantee principal and
                 interest. In guaranteeing the securities, the Enterprises assume the credit risk
March 13, 2018   from possible default of the underlying mortgages. To mitigate this risk, the
                 Enterprises require lenders from whom they purchase residential mortgages to
                 make contractual representations and warranties wherein the lenders represent
                 that the mortgages meet specific underwriting requirements.

                 Historically, the Enterprises have relied on the lenders’ representations and
                 warranties that underwriting requirements were met and conducted limited due
                 diligence at the time the mortgages were purchased. When mortgages defaulted
                 or the borrower missed payments, the Enterprises would then review the loan
                 files for evidence of breach of the representations and warranties and exercise
                 their contractual rights to require lenders to repurchase, or buy back, non-
                 compliant loans. The Enterprises’ contractual rights to put back non-compliant
                 loans at any point during the term of the loans enabled the Enterprises to
                 reduce losses caused by underwriting defects.

                 In September 2012, the Federal Housing Finance Agency (FHFA) announced
                 that the Enterprises would launch a new representation and warranty
                 framework (new framework). The objective of the new framework was to
                 enhance transparency and certainty for lenders by clarifying when a mortgage
                 loan may be subject to repurchase. The new framework, designed by the
                 Enterprises to meet FHFA’s stated objective, shifted some risk of non-
                 compliance with representations and warranties from the lenders to the
                 Enterprises (and therefore to taxpayers). The new framework required
                 operational changes at the Enterprises to mitigate the additional risk. FHFA
                 recognized the need to test the adequacy of those operational changes, through
                 its supervisory activities, to ensure that the additional risk had been mitigated.

                 FHFA is charged by the Housing and Economic Recovery Act of 2008
                 (HERA) with, among other things, ensuring that the Enterprises and the
                 Federal Home Loan Banks operate in a safe and sound manner. Within FHFA,
                 the Division of Enterprise Regulation (DER) is responsible for the supervision
                 of the Enterprises. We recently issued the results of a completed audit, FHFA’s
                 2015 and 2016 Supervisory Activities, as Planned, Addressed Identified Risks
                 with Freddie Mac’s New Representation and Warranty Framework, AUD-
                 2017-009, available online at www.fhfaoig.gov/reports/auditsandevaluations.
                 In that audit, we found that for the 2015 examination cycle, DER planned and
                 performed two ongoing monitoring activities to address identified risks with
                 Freddie Mac’s implementation of the new framework. For the 2016
                 examination cycle, DER identified the new framework as a supervisory focus.
                 DER’s 2016 Freddie Mac supervisory plan included three new framework-
                 related targeted examinations and one ongoing monitoring activity. During the
                 2016 examination cycle, we found that DER completed two of the planned
AUD-2018-006     targeted examinations, deferred the other to 2017, and completed the ongoing
                 monitoring activity.
March 13, 2018
                 This audit follows on that work. In this audit, we sought to determine whether
                 DER performed its planned procedures and sufficiently supported its
                 conclusions for one of the Freddie Mac targeted examinations completed
                 during the 2016 examination cycle, entitled Representation and Warranty
                 Framework. We found that DER performed its planned procedures, and
                 prepared the required examination documents. The conclusions DER presented
                 in the Conclusion Letter were also consistent with those detailed in the targeted
                 examination workpapers. However, the examiner did not prepare the
                 examinaton workpapers for this targeted examination in a manner that
                 provided a third party with a clear understanding of the examination work
                 performed. Specifically, certain examination work that, upon inquiry, was cited
                 by the Examination Manager to support the conclusion reached for this
                 targeted examination was not referenced in the Analysis Memorandum or
                 documented in the workpapers.

                 We make one recommendation in this report. In a written management
                 response, FHFA agreed that examiners should document their independent
                 analysis and rationale for how conclusions and findings were reached in
                 examination workpapers. While FHFA disagreed with various statements in
                 the report, it generally agreed with our recommendation. FHFA stated that
                 DER is in the process of rescinding and replacing current examiner guidance
                 for documenting targeted examinations, and will train examination staff on the
                 revised guidance. To the extent the revised guidance addresses the shortcoming
                 with the examination workpapers identified in this report, FHFA’s planned
                 corrective actions are responsive to our recommendation.

                 We are also issuing today the results of our audit of DER’s execution of a
                 targeted examination of Fannie Mae’s risk management activities related to the
                 new framework. See FHFA Completed its Planned Procedures for a 2015
                 Representation and Warranty Framework Targeted Examination at Fannie
                 Mae, but Did Not Document a Change to Planned Testing, AUD-2018-005,
                 available online at www.fhfaoig.gov/reports/auditsandevaluations.
                 This report was prepared by James Lisle, Audit Director; April Ellison,
                 Auditor-in-Charge; and Brian Maloney, Auditor; with the assistance of Bob
                 Taylor, Assistant Inspector General for Audits. We appreciate the cooperation
                 of FHFA staff, as well as the assistance of all those who contributed to the
                 preparation of the report.

                 This report has been distributed to Congress, the Office of Management and
AUD-2018-006     Budget, and others and will be posted to our website, www.fhfaoig.gov.

March 13, 2018   Marla A. Freedman, Deputy Inspector General for Audits /s/
TABLE OF CONTENTS ................................................................
EXECUTIVE SUMMARY .............................................................................................................2

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

BACKGROUND .............................................................................................................................7
      DER Supervisory Process .........................................................................................................7
      The New Framework Sought to Provide Greater Certainty to the Lender, Shifting
      Some Risk to the Enterprises ....................................................................................................8
      Prior OIG Work on the New Framework .................................................................................9

FACTS AND ANALYSIS.............................................................................................................10
      Required Documents Were Prepared and Approved for the 2016 Representations and
      Warranties Framework Targeted Examination of Freddie Mac .............................................10
      While We Do Not Take Issue with DER’s Conclusion, the Supporting Workpapers
      Did Not Sufficiently Document the Examination Work ........................................................11
                                       Identified During the Targeted Examination
      Was Referred to Ongoing Monitoring ....................................................................................12

FINDING .......................................................................................................................................13

CONCLUSION ..............................................................................................................................14

RECOMMENDATION .................................................................................................................14

FHFA COMMENTS AND OIG RESPONSE ...............................................................................14

OBJECTIVE, SCOPE, AND METHODOLOGY .........................................................................15

APPENDIX: FHFA MANAGEMENT RESPONSE ....................................................................17

ADDITIONAL INFORMATION AND COPIES .........................................................................19




                                            OIG • AUD-2018-006 • March 13, 2018                                                               5
ABBREVIATIONS .......................................................................

DER                Division of Enterprise Regulation

EIC                Examiner-in-Charge

Enterprises        Fannie Mae and Freddie Mac

ERM                Enterprise Risk Management

Fannie Mae         Federal National Mortgage Association

FHFA               Federal Housing Finance Agency

Freddie Mac        Federal Home Loan Mortgage Corporation

HERA               Housing and Economic Recovery Act of 2008

LRM                Loan Ranking Model

New framework      Representation and Warranty Framework

OIG                Federal Housing Finance Agency Office of Inspector General

OPB                Operating Procedures Bulletin

QC                 Quality Control




                         OIG • AUD-2018-006 • March 13, 2018                        6
BACKGROUND ..........................................................................

DER Supervisory Process

Created by Congress in 2008, FHFA is charged by HERA with, among other things, the
supervision of the Enterprises. Its mission as a federal financial regulator includes ensuring
the safety and soundness of the Enterprises so that they serve as a reliable source of liquidity
and funding for housing finance and community investment. FHFA exercises its supervision
of the Enterprises through DER. Like other federal financial regulators, FHFA maintains that
it uses a risk-based approach to carry out its supervisory activities.

DER executes supervisory activities, which consist of ongoing monitoring and targeted
examinations conducted in accordance with a supervisory plan. The FHFA Examination
Manual states that:

   •   The purpose of ongoing monitoring is to analyze real-time information and to use
       those analyses to identify Enterprise practices and changes in an Enterprise’s risk
       profile that may warrant supervisory attention. This approach allows staff to monitor
       and evaluate the Enterprise’s operations and assess risk management.
   •   Targeted examinations are a critical component of supervision and will be undertaken,
       as needed, based on risk. The purpose of targeted examinations is to allow for a deep
       or comprehensive assessment of the area under review.”

According to DER’s Operating Procedures Bulletin (OPB) 2013-DER-OPB-04, DER
Supervisory Activities (September 19, 2013), targeted examinations are designed to assess a
particular area, product, risk, or activity of the Enterprise and by definition are narrow in
scope. This OPB directs DER examiners to conduct detailed analysis and testing in order to
develop specific conclusions.

The FHFA Examination Manual and DER’s OPBs define expectations and approval
requirements for examiner workpapers. According to 2013-DER-OPB-04 and
2014-DER-OPB-01, Guidelines for Preparing Supervisory Products and Examination
Workpapers (January 27, 2014), required documents for targeted examinations are:
   •   Procedures Document – sets forth the steps performed to achieve the objective of the
       supervisory activity and provides the official agency record of evidence to support the
       execution of the targeted examination. The Procedures Document must be approved by
       the Lead Examiner and Examination Manager.
   •   Request Letter – announces the objective and scope of the targeted examination to the
       Enterprise, requests the Enterprise to schedule a kickoff and subsequent meetings with
       management, and requests timely delivery of documentation to be produced by the



                              OIG • AUD-2018-006 • March 13, 2018                                  7
         Enterprise. The Request Letter must be approved by the Lead Examiner, Examination
         Manager, and Examiner-in-Charge (EIC).
    •    Meeting Notes – document the periodic status meetings with management that are
         conducted throughout the targeted examination to ensure that management is kept
         apprised of any preliminary findings or emerging concerns. Meeting Notes must be
         approved by the Lead Examiner and Examination Manager.
    •    Analysis Memorandum – constitutes the main work product from the targeted
         examination that supports the Conclusion Letter, and provides the complete record of the
         work performed, findings, and conclusions. The Analysis Memorandum should include
         hyperlinks or references to supporting workpapers and must be approved by the Lead
         Examiner, Examination Manager, and EIC.
    •    Conclusion Letter – communicates conclusions from targeted examinations to the
         Enterprise. Conclusion Letters must be approved by the Lead Examiner, Examination
         Manager, EIC, and DER Deputy Director.
The FHFA Examination Manual directs that examiner workpapers, on which the Analysis
Memorandum is based, must be prepared in sufficient detail to provide a clear understanding of
the examination work performed. Further, 2014-DER-OPB-01, directs DER examiners to
prepare workpapers with sufficient detail and explanation so that they can provide a third party
with a clear understanding of the examination work performed, the examination findings,
conclusions, and ratings reached, and any implications of the findings, conclusions, and ratings.

The New Framework Sought to Provide Greater Certainty to the Lender, Shifting Some
Risk to the Enterprises

Implementation of the new framework shifted some risk of non-compliance with
representations and warranties from the lenders to the Enterprises. As a result, the Enterprises’
quality control (QC) programs 1 became increasingly important to mitigate origination quality
risk and credit risk since, for loans covered by the new framework, the Enterprises would no
longer be able to seek repurchase from a lender for the life of the loan as a result of some
representation and warranty breaches. For loans acquired under the new framework, both
Enterprises represented that they would conduct most QC reviews within 30 to 120 days after
delivery of the loan to assess whether specific representations and warranties were satisfied. 2

1
  A QC program defines the standards for loan quality, establishes processes designed to achieve those
standards, and mitigates risks associated with the origination processes. A QC program includes a documented
QC plan that outlines requirements for validating that loans are originated in accordance with the Enterprise’s
established policies and procedures.
2
  For example, Freddie Mac QC reviews assess representations and warranties related to the underwriting of
the borrower, including the seller’s assessment of borrower’s loan terms, credit history employment, income,
assets, and other information used for qualifying the borrower for the mortgage; the assessment also includes
the underwriting of the mortgaged premises, which is the analysis of the description and valuation of the
mortgaged premises to determine its adequacy as collateral for the mortgage.




                                   OIG • AUD-2018-006 • March 13, 2018                                            8
The Enterprises also stated that they would develop and use new technologies and data
gathering tools to identify loans that were not originated in accordance with applicable
underwriting and eligibility requirements. Freddie Mac developed the Loan Ranking Model
(LRM) 3 to assist in targeting QC reviews on loans with a greater risk of defect, 4 and a
representation and warranty tracking tool to track loan events that impact relief dates.

Prior OIG Work on the New Framework

A 2014 OIG audit found that FHFA mandated the new framework despite significant unresolved
operational risks to the Enterprises. The audit also found that neither Enterprise had implemented
the processes, procedures, nor systems needed to operate within the new framework before it
went into effect in 2013. The 2014 audit report made two recommendations to FHFA, of which
one is relevant to the scope of this audit:

         [A]ssess the current state of the Enterprises’ critical risk assessment tools,
         representations and warranties tracking systems, and any other systems,
         processes, or infrastructure to determine whether the Enterprises are in a position
         to minimize financial risk that may result from the new framework. The results of
         this assessment should document any areas of identified risk, planned actions, and
         corresponding timelines to mitigate each area of identified risk. Further, this
         assessment should provide an estimate of when each Enterprise will be reasonably
         equipped to work safely and soundly within the new framework. 5

In its written response, FHFA partially agreed with this recommendation, stating that:

         FHFA examination staff will continue to examine and review the Enterprises’
         loan purchase operations, including those affected by the representations and
         warranties framework. DER examination staff will request the Enterprises to
         provide information about operational changes needed at each Enterprise for safe
         and sound implementation of the new framework, and DER will take this
         information into account in developing its examination plans for 2015.



3
  LRM uses loan information to rank loans according to their probability of containing a defect to produce a
targeted QC sample.
4
  Freddie Mac defines defect as a loan-level deficiency that breaches a term contained in the purchase
documents in effect at the time of mortgage purchase. Freddie Mac categorizes defects depending on their
severity (e.g., a “finding” would not require a correction or a remedy from the seller, a “significant defect”
would require the repurchase of the mortgage or possibly an offer of a repurchase alternative).
5
 See OIG, FHFA’s Representation and Warranty Framework (Sept. 17, 2014) (AUD-2014-016) (online at
www.fhfaoig.gov/Content/Files/AUD-2014-016.pdf).




                                    OIG • AUD-2018-006 • March 13, 2018                                          9
More recently, a September 2017 OIG audit assessed (1) whether DER’s planned supervisory
activities relating to Freddie Mac’s implementation of the new framework for the 2015 and
2016 examination cycles could be tracked to its risk assessments and supervisory strategies
and (2) whether DER executed these planned supervisory activities during the 2015 and 2016
examination cycles. 6 As detailed in the 2017 audit report, we found that the risks identified by
DER with respect to Freddie Mac’s implementation of the new framework for the 2015
examination cycle focused on Freddie Mac’s
To address the identified risk, DER planned and performed two ongoing monitoring activities
related to       . For the 2016 examination cycle, DER identified the new framework as a
supervisory focus. DER’s 2016 Freddie Mac supervisory plan included three new framework-
related targeted examinations and one ongoing monitoring activity. During the 2016
examination cycle, DER completed two of the planned targeted examinations, deferred the
other to 2017, and completed the ongoing monitoring activity. We selected one of the
completed 2016 targeted examinations, entitled Representation and Warranty Framework, for
this audit because its objective directly correlated with Freddie Mac’s loan purchase
operations effected by the new framework.

In this audit, we assessed whether DER completed the procedures as planned and sufficiently
supported its conclusions for one completed 2016 targeted examination, entitled
Representation and Warranty Framework.


FACTS AND ANALYSIS ...............................................................

Required Documents Were Prepared and Approved for the 2016 Representations and
Warranties Framework Targeted Examination of Freddie Mac

As discussed above, DER completed its planned targeted examination of the new framework
at Freddie Mac during the 2016 examination cycle. According to the Request Letter to
Freddie Mac announcing the targeted examination, the objective was “To examine
Freddie Mac’s                          specifically those

Required targeted examination documents – the Request Letter, Procedures Document,
Analysis Memorandum, and Conclusion Letter – were completed, reviewed, and approved by
the appropriate DER official(s) in accordance with the requirements of 2013-DER-OPB-04.
The targeted examination’s Meeting Notes were not individually approved; however, a DER
official told us that since they were linked to the approved Analysis Memorandum, they are

6
 See OIG, FHFA’s 2015 and 2016 Supervisory Activities, as Planned, Addressed Identified Risks with Freddie
Mac’s New Representation and Warranty Framework (Sept. 22, 2017) (AUD-2017-009) (online at
www.fhfaoig.gov/Content/Files/AUD-2017-009FRERWFExaminationsredacted.pdf).



                                 OIG • AUD-2018-006 • March 13, 2018                                         10
considered approved. Additionally, our review of the Conclusion Letter found that DER’s
conclusion – We have                             related to        that Freddie Mac made to
its                          affected by the                    -- was consistent with
conclusions detailed in the Analysis Memorandum. DER also performed the required internal
quality control review of the targeted examination’s workpapers prior to issuance of the
Conclusion Letter.

While We Do Not Take Issue with DER’s Conclusion, the Supporting Workpapers Did
Not Sufficiently Document the Examination Work

The planned targeted examination scope and procedures in the approved Procedures
Document called for examiners to                  made at Freddie Mac for the
                        of the                                        meet with
management to                                   meet with Internal Audit to
               Freddie Mac’s                                       According to the
Procedures Document, the targeted examination was to focus on Freddie Mac’s
including, but not limited to, its


In the targeted examination’s Analysis Memorandum, the examiners concluded that:
    Freddie Mac made                    to the                        to support the
                                       which included
                                          Freddie Mac was
                                       In addition, the
                    regarding the             of certain systems
                  such as whether the      has been
                         The Memorandum also
                       that found the

                  However, the Analysis Memorandum did not document or reference any
examination work that explained how DER concluded on


As a result, we asked the Examination Manager if he thought he had done enough work to
reach the conclusion in the Analysis Memorandum. He reported that he believed the
examiners did enough to answer the questions because it was not the first time he or his
examiners looked at the                                            process. He said that he
considered DER’s entire body of work in this area, which included (1) the results of a

7
  Base (random) reviews and targeted reviews make up the Performing Loan QC reviews. Targeted reviews are
focused on loans with a higher probability of defect (riskier loans).



                                 OIG • AUD-2018-006 • March 13, 2018                                        11
concurrent targeted examination on Freddie Mac’s                                     process,
which included                    of individual             , and (2) work being performed
on an ongoing monitoring activity, which included the review of
                                reports. This information, however, was not summarized or
otherwise documented in the targeted examination’s workpapers or the Analysis
Memorandum.

We recognize that examiner reliance on work performed across the spectrum of supervisory
activities to formulate conclusions for a specific targeted examination is prudent and promotes
the efficiency of the supervisory effort. DER, in 2014-DER-OPB-01, directs that workpapers
supporting the examination conclusion(s) be sufficiently detailed and clear to provide a third
party with a clear understanding of the examination work performed and conclusions reached.
For this targeted examination, the work cited by the Examination Manager to support DER’s
conclusions—the concurrent targeted examination on
                                                 and work performed on an ongoing monitoring
activity
reports)—was not referenced in the Analysis Memorandum or documented in the workpapers.

In technical comments provided to this report, DER contended that the examiner’s analysis as
documented in the Procedures Document and Analysis Memorandum provided sufficient
support for the conclusions reached in this targeted examination and satisfies the requirements
of 2014-DER-OPB-01. We disagree. Our review of the workpapers supporting this targeted
examination identified no description of the examination work performed or other
examination work relied upon to enable an examiner to conclude on                     of the
         made to Freddie Mac’s                             in response
As discussed above, the Examination Manager for this targeted examination told us that he
considered DER’s other body of work in this area and specifically identified his consideration
of the work conducted as part of two specific supervisory activities. His verbal explanation
provided an essential link in understanding the basis for DER’s conclusion, and we do not
take issue with its conclusion. Nevertheless, verbal explanations fall short of the DER
documentation standard that requires workpapers to provide a third party with a clear
understanding of the examination work performed and the conclusions reached.

                                        Identified During the Targeted Examination Was
Referred to Ongoing Monitoring

During our review of the Analysis Memorandum, we found that Freddie Mac management


                    The Analysis Memorandum documented that DER examiners were told
by Freddie Mac management, in a September 2016 meeting, that they had


                             OIG • AUD-2018-006 • March 13, 2018                                  12
                                  The Analysis Memorandum stated that this
             Freddie Mac management                                              The Lead
Examiner told us this matter did not rise to the level of an examination finding because Freddie
Mac was aware of the issue, raised it with the DER examiners, and developed action items to
address it. The Lead Examiner also noted that the issue was outside of the scope of the targeted
examination and that more work to support an examination finding would have been needed.
Instead, DER decided to discuss the matter in the Analysis Memorandum and follow up on it in a
subsequent ongoing monitoring activity.
We found that DER followed up on the                                                 during 2017 as an
ongoing monitoring activity. Examiners found that
                                         Freddie Mac                                                 In that
same month,                           Freddie Mac management
                                                                               8
                                                                       In addition, DER’s ongoing
monitoring meeting notes documented that Freddie Mac had taken steps
       , including
                                          The Lead Examiner responsible for this ongoing
monitoring activity told us that his review of reports generated by Freddie Mac found that
Freddie Mac has been                             He further reported that DER planned a targeted
                                                                                         9
examination during 2018 to assess Freddie Mac’s


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

DER’s 2014-DER-OPB-01 directs that workpapers supporting the examination conclusion(s)
be sufficiently detailed and clear to provide a third party with a clear understanding of the
examination work performed and conclusions reached. For this targeted examination, we
found that DER concluded on                                    Freddie Mac
                                                       without sufficiently documenting the
work it relied on. Upon inquiry, the Examination Manager explained how the examiners
reached their conclusion by considering DER’s entire body of work in this area. However, the
work cited by the Examination Manager to support DER’s conclusion was not referenced in
the Analysis Memorandum or documented in the workpapers supporting this targeted
examination. As a result, the Analysis Memorandum and supporting workpapers for the
targeted examination did not provide a third party with a clear understanding of the work
performed and did not meet the DER documentation standard.


8
 DER’s Freddie Mac examination team prepares and updates quarterly the results for each ongoing monitoring
activity in a Quarterly Risk Assessment.
9
    This targeted examination is included on DER’s 2018 supervisory plan for Freddie Mac.



                                    OIG • AUD-2018-006 • March 13, 2018                                      13
CONCLUSION ............................................................................

We found that DER performed its planned procedures and prepared the required examination
documents for the 2016 targeted examination entitled Representation and Warranty
Framework. The conclusions DER presented in the Conclusion Letter for this targeted
examination were consistent with those detailed in the targeted examination workpapers.

DER recognizes the importance of documenting its examination work in workpapers by
requiring that workpapers be prepared in a manner that provides a third party with a clear
understanding of the examination work performed. In this audit, we found that the Analysis
Memorandum did not document or reference examination work that explained how DER
concluded on
                 Other examination work verbally cited by the Examination Manager to
support DER’s conclusion was not referenced in the Analysis Memorandum or documented in
the workpapers supporting this targeted examination. As a result, the workpapers did not
provide a third party with a clear understanding of the examination work performed, which is
required by DER’s documentation standard.


RECOMMENDATION .................................................................

We recommend that FHFA reinforce, in examiner training, the need to prepare workpapers
for targeted examinations with sufficient detail and clarity to provide a third party with a clear
understanding of the examination work performed; the examination findings, conclusions, and
ratings reached; and any implications of the findings, conclusions, and ratings.


FHFA COMMENTS AND OIG RESPONSE .....................................

We provided FHFA an opportunity to respond to a draft of this audit report. FHFA provided
technical comments on the draft report, which we incorporated as appropriate. In its
management response, which is included in the Appendix to this report, FHFA agreed that
examiners should document their independent analysis and rationale for how conclusions and
findings were reached in examination workpapers. While FHFA disagreed with various
statements in the report, it generally agreed with our recommendation. FHFA stated that DER
is in the process of rescinding and replacing 2014-DER-OPB-01. According to FHFA, the
revised guidance will articulate to DER examination staff expectations for documentation of
targeted examinations to support findings and conclusions to enable effective quality control
and management review. Also, by September 28, 2018, DER will provide training to all


                              OIG • AUD-2018-006 • March 13, 2018                                    14
examination staff (including Examiners-in-Charge and examination managers) on the
provisions of the revised OPB with regard to requirements that examiners should follow when
documenting targeted examination conclusions and findings. To the extent the revised
guidance addresses the finding in this report, we consider FHFA’s planned corrective actions
responsive to our recommendation.


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

We conducted this audit to assess whether DER completed the procedures as planned and
sufficiently supported its conclusions for the 2016 targeted examination entitled
Representation and Warranty Framework.

To accomplish our objective, we reviewed the FHFA Examination Manual (December 2013)
and the related examination modules for Credit Risk Management (July 2013), Enterprise
Risk Management (August 2013), and Operational Risk Management (October 2013); as well
as guidance issued by FHFA and DER related to conduct of and supervisory products for
targeted examinations. In addition, we reviewed Freddie Mac Guide Bulletins and Industry
Letters related to the new framework.

Specifically, for Freddie Mac, we:

   •   Reviewed DER’s documentation for the 2016 Representation and Warranty
       Framework targeted examination, including the Procedures Document, Request Letter,
       Meeting Notes, Analysis Memorandum, Conclusion Letter, and supporting
       workpapers to see that the required documents were completed and approved in
       accordance with FHFA and DER guidance, and supported the conclusions reached for
       the targeted examination.

   •   Interviewed DER personnel to gain an understanding of the supervisory activities
       planned and performed to supervise Freddie Mac’s implementation of the new
       framework.

   •   Reviewed DER’s workpapers for other targeted examinations and ongoing monitoring
       related to the new framework performed during the 2016 and 2017 examination cycles
       to determine how matters mentioned in discussions with examiners or in the
       workpapers for the 2016 Representation and Warranty Framework targeted
       examination were influenced by or followed up on in those other supervisory
       activities.




                             OIG • AUD-2018-006 • March 13, 2018                               15
   •   Reviewed the following Freddie Mac guides and bulletins:

           o 2012-18, New Representation and Warranty Framework (September 11, 2012)

           o 2014-8, Selling Representation and Warranty Framework Updates (May 12,
             2014)

           o 2014-21, Selling Representation and Warranty Framework Life-of-Loan
             Exclusions (November 20, 2014)

           o 2015-17, Selling Representation and Warranty Framework – Origination
             Defects and Remedies (October 7, 2015)

           o 2016-1, Selling Representation and Warranty Framework – Independent
             Dispute Resolution (February 2, 2016)

           o Freddie Mac, Quality Control Best Practices (July 2017)

           o Freddie Mac Bulletin 2017-3, Collateral Representation and Warranty Relief
             and Appraisal Requirement Updates (March 22, 2017)

We conducted this performance audit from September 2017 through March 2018 in accordance
with generally accepted government auditing standards. Those standards require that we plan and
perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for the
findings and conclusions based on our audit objectives. We believe that the evidence obtained
provides a reasonable basis for our findings and conclusions based on our audit objectives.




                             OIG • AUD-2018-006 • March 13, 2018                               16
APPENDIX: FHFA MANAGEMENT RESPONSE .............................

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                              OIG • AUD-2018-006 • March 13, 2018       17
OIG • AUD-2018-006 • March 13, 2018   18
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




                               OIG • AUD-2018-006 • March 13, 2018                         19