oversight

FHFA's Oversight of the MPF Xtra Program

Published by the Federal Housing Finance Agency, Office of Inspector General on 2014-04-22.

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

              Federal Housing Finance Agency
                  Office of Inspector General




          FHFA’s Oversight of the
            MPF Xtra Program




Evaluation Survey Report  ESR-2014-007  April 22, 2014
                                                 April 22, 2014


TO:              Fred Graham, Deputy Director, Division of Federal Home Loan Bank Regulation
                 Nina Nichols, Deputy Director, Division of Supervision Policy and Support


FROM:            Richard Parker, Deputy Inspector General for Evaluations


SUBJECT:         FHFA’s Oversight of the Federal Home Loan Banks’ Mortgage Partnership
                 Finance (MPF) Xtra Program (ESR-2014-007)


Summary of this Memorandum

This memorandum closes our survey of the Federal Housing Finance Agency’s (FHFA)
oversight of the Mortgage Partnership Finance (MPF) Xtra program as administered by the
Federal Home Loan Bank of Chicago (FHLBank of Chicago).

We conclude that FHFA’s oversight of the MPF Xtra program is not ripe for evaluation at this
time. Although there are unresolved issues related to FHLBank of Chicago’s quality assurance
processes, it appears that FHFA has been overseeing the FHLBank’s efforts to remediate them.
Accordingly, we will monitor developments in the MPF Xtra program and initiate future work
on this topic as necessary.

Background

The twelve FHLBanks that comprise the FHLBank System1 make secured loans, called
advances, to their members.2 Members, which are both owners and customers of their
1
  The Federal Home Loan Bank (FHLBank) System was created by the FHLBank Act of 1932 to support mortgage
lending and community investment. The FHLBank System is comprised of 12 regional banks and the FHLBank
System’s fiscal agent, the Office of Finance. The 12 FHLBanks are jointly and severally liable for each other’s
consolidated obligations. In the event of default, FHFA can “allocate the outstanding liability among one or more of
the remaining [FHLBanks] on a pro rata basis or on any other basis that the FHFA may determine.” FHLBank of
Chicago, Form 10-K for the Fiscal Year Ended December 31, 2013, at 25 (Mar. 13, 2014). For a description of the
FHLBank System and its operations see OIG, Semiannual Report to the Congress: April 1, 2013, through
September 30, 2013, at 45 (Oct. 31, 2013) (online at:
http://www.fhfaoig.gov/Content/Files/SixthSemiannualReport_0.pdf).
2
 In total, the FHLBanks have about 7,500 members. Members of the FHLBanks include banks, thrifts, credit
unions, insurance companies, or community development financial institutions.



      Federal Housing Finance Agency Office of Inspector General • ESR-2014-007 • April 22, 2014
                                                         1
FHLBanks, must purchase the FHLBanks’ capital stock to obtain credit in the form of secured
loans and letters of credit.

MPF – The Umbrella Program
In 1997, the Federal Home Finance Board (FHFB)3 approved the creation of the Mortgage
Partnership Finance (MPF) Program. The purpose of the Program is to create partnerships
between FHLBanks and their small and mid-sized members by which the members gain greater
access to the secondary mortgage market. The FHLBanks provide this access through sub-
programs made available to the members under the MPF Program.4

The MPF Program is designed to allocate the risks associated with home mortgage finance
between the member and its FHLBank. It is premised on the idea that members have expertise in
lending and managing credit risk5 and the FHLBanks have expertise in managing interest rate
and prepayment risk.6 Essentially, an FHLBank purchases loans from its members and takes on
the associated prepayment and interest rate risks. The FHLBank manages the loans by hedging
the interest rate and prepayment risks. The member, which has sold its loans to the FHLBank,
continues to receive income from originating and servicing the loans and, thus, retains the
servicing risk.7 Both the FHLBank and the member share the risk of loss.

MPF Xtra
In October 2008, FHFA announced the MPF Xtra program. Under it, the FHLBank of Chicago
purchases conforming fixed rate residential mortgages from participating members across the
FHLBank System and concurrently sells them to the Federal National Mortgage Association
(Fannie Mae).8 Thus, MPF Xtra provides small- and mid-size members with greater access to
the secondary mortgage market, the corresponding liquidity, and several additional advantages.
These additional advantages distinguish MPF Xtra from the other MPF sub-programs.

Under MPF Xtra, the members – called Participating Financial Institutions (PFIs) – transfer to
Fannie Mae the interest rate, prepayment, and credit risks associated with the loans they sell, but

3
  FHFB was the regulator of the FHLBanks until the Housing and Economic Recovery Act of 2008 (HERA)
replaced it with FHFA.
4
 These programs include the Original MPF, MPF 100, MPF 125, MPF Plus, MPF Government, and MPF Xtra. We
surveyed FHFA’s oversight of the FHLBank of Chicago’s administration of MPF Xtra – a newer MPF program.
5
    Credit risk refers to the risk that a borrower will default on a mortgage.
6
  Interest rate risk refers to the risk that changes in interest rates may adversely affect an institution’s financial
condition. Prepayment risk refers to the risk that mortgages will be paid off early resulting in less interest income
for the holders of the debt.
7
  The MPF Program permits members to choose a service release option under which they may sell their servicing
rights to another member.
8
 Fannie Mae is currently the only investor in the MPF Xtra program. Officials of the FHLBank of Chicago told us
that it is working with the Federal Home Loan Mortgage Corporation (Freddie Mac) to assess the feasibility of
Freddie Mac becoming an investor in the MPF Xtra program.




         Federal Housing Finance Agency Office of Inspector General • ESR-2014-007 • April 22, 2014
                                                              2
generally retain the servicing rights and the fees they generate.9 Since the PFIs do not retain
credit risk associated with the loans sold under MPF Xtra they are not subject to any risk-based
capital or credit risk collateral requirements. Moreover, there are no leverage capital
requirements for PFIs that are depository institutions.

As illustrated in Figure 1, the MPF Xtra program works as follows: PFIs from each MPF Xtra
Bank10 originate and sell fixed rate, conforming loans directly to the FHLBank of Chicago.11
The FHLBank of Chicago immediately sells these MPF Xtra loans to Fannie Mae.12 The
FHLBank of Chicago earns fees for its services.

                                       FIGURE 1. MPF Xtra Transaction
                PFIs
       MPF Xtra Bank Boston

                PFIs
       MPF Xtra Bank Chicago

                PFIs
        MPF Xtra Bank Dallas

                PFIs
     MPF Xtra Bank Des Moines

                PFIs               Mortgages                                Mortgages
     MPF Xtra Bank Pittsburgh                       FHLBank of Chicago                           Fannie Mae

                PFIs                   Cash                                     Cash
     MPF Xtra Bank San Francisco

                PFIs
       MPF Xtra Bank Seattle

                PFIs
       MPF Xtra Bank Topeka




9
 Smaller members that sell loans to Fannie Mae normally do so through third party loan aggregators. The
aggregators may require the members to surrender their servicing rights as a condition of the transaction.
10
  FHLBanks that FHFA has authorized to participate in MPF Xtra are called MPF Xtra Banks. Among other
things, they certify their members to participate in MPF Xtra pursuant to guidelines established under the MPF Xtra
program.
11
  The PFIs sell MPF Xtra loans directly to FHLBank of Chicago regardless of whether or not the PFI is a member
institution of the FHLBank of Chicago. Further, the FHLBank of Chicago’s own PFIs sell MPF Xtra loans to it just
as the PFIs of other MPF Xtra Banks sell loans to it. Thus, the FHLBank of Chicago is represented on both the left
and right hand sides of Figure 1.
12
  The FHLBank of Chicago sells the MPF Xtra loans to Fannie Mae for cash. Thereafter, Fannie Mae may
securitize the mortgages and sell the resulting mortgage-backed securities to investors.




         Federal Housing Finance Agency Office of Inspector General • ESR-2014-007 • April 22, 2014
                                                         3
The FHLBank of Chicago is responsible for the representations and warranties associated with
the mortgages that it sells to Fannie Mae under the MPF Xtra program.13 If Fannie Mae
determines that a representation or warranty was breached, then it can require the FHLBank of
Chicago to repurchase the MPF Xtra loan. The FHLBank of Chicago may, in turn, require the
PFI to repurchase the mortgage from it. If the PFI has failed, however, then the MPF Xtra Bank
of which the PFI is a member assumes the fallen PFI’s repurchase obligation. In its 2013 Annual
Report, the FHLBank of Chicago estimated that its mortgage repurchase liability to Fannie Mae
for MPF Xtra loans as of December 31, 2013 was less than $1 million.14

MPF Xtra Loan Volume
The number of MPF Xtra Banks participating in the MPF Xtra program has increased since it
began in 2008. As of January 2014, there were eight MPF Xtra Banks offering MPF Xtra, three
of which joined in 2013.15 The MPF Xtra program has been a growing business for the
FHLBank of Chicago. As depicted in Figure 2, the growth is due to an increase in the volume of
MPF Xtra loans.

      FIGURE 2. Total Aggregate Outstanding Unpaid Principal Balance of MPF Xtra Loans ($ millions)

          $15,000
          $13,500
          $12,000
          $10,500
           $9,000
           $7,500
           $6,000
           $4,500
           $3,000
           $1,500
               $0
                         2008          2009            2010           2011            2012           2013

Source: FHLBank of Chicago.




13
  Representations and warranties are assurances that lenders make to the Enterprises about the quality of loans being
purchased or guaranteed by the Enterprises. If an Enterprise determines that a loan does not meet the criteria that
the lender claimed the loan met, then the Enterprise may issue a request to the lender to repurchase the loan.
14
     See FHLBank of Chicago, Form 10-K for the Fiscal Year Ended December 31, 2013, at 74 (Mar. 13, 2014).
15
 The FHLBanks of Chicago, Boston, Des Moines, Pittsburgh, Topeka, Seattle, San Francisco, and Dallas offer
MPF Xtra to their members.




         Federal Housing Finance Agency Office of Inspector General • ESR-2014-007 • April 22, 2014
                                                         4
FHFA officials consider MPF Xtra to be a small FHLBank program even though MPF Xtra loan
volume has increased substantially since the program began in 2008. In 2013 the MPF Xtra
program represented 20% of the FHLBank of Chicago’s member-focused business of
approximately $71 billion, up from 18% in 2012 and 12% in 2011.16 MPF Xtra loans represent
only one to two percent of Fannie Mae’s single-family loan acquisitions. So, although MPF Xtra
has grown steadily, the small size of the program relative to the FHLBank’s and Fannie Mae’s
other business lines indicates that it presents minimal risk to the FHLBank and Fannie Mae.

FHFA Mandates Improved Quality Assurance Process
In 2012, FHFA conducted its annual examination of the FHLBank of Chicago. During the credit
risk portion of the examination, FHFA identified a number of issues related to the quality
assurance process for the entire MPF Program.17 Based on its examination, FHFA directed the
FHLBank of Chicago to enhance and standardize its quality assurance process. Thereafter, the
FHLBank:

         Consolidated risk management operations under a single division at the FHLBank of
          Chicago, called Risk Management and Strategic Initiatives.

         Revised its sampling methodology in January 2014 by increasing the sampling minimum
          for MPF Xtra loans to 10% for all PFIs to meet the minimum quality assurance standards
          set by Fannie Mae.

         Increased the frequency of its quality assurance reviews to sample loans on a monthly
          cycle rather than sampling in arrears on an annual cycle.

In addition, the FHLBank of Chicago is engaged in the development of an MPF Risk
Framework. The framework outlines the processes for identifying, assessing, and mitigating
risks associated with the purchase and sale of loans under the entire MPF Program. It is
organized around 11 core issues.18

The MPF Risk Framework is intended to provide written guidelines by which regular
assessments may be made in the major risk management areas. It is also intended to provide a
16
  In addition to the MPF Xtra program, the FHLBank of Chicago’s member-focused business activities include
other MPF programs, advances, and standby letters of credit. The FHLBank of Chicago’s total member-focused
business for 2012 and 2011 was $62 billion and $61 billion, respectively.
17
  For example, FHFA found problems with the threshold analysis used to determine the sample size of loans to be
reviewed for each PFI. The methodology was designed to automatically decrease the sample size for PFIs that had
a nominal incidence of loan defects. FHFA, however, found that a similar policy did not exist to automatically
increase the sample size for PFIs that had a high incidence of loan defects. Additionally, FHFA found no instances
where the sample size was increased for a PFI with a high loan defect rate.
18
  The core issues are: (1) Market Research; (2) Quality Control Sampling Methodology; (3) Quality Control
Standards and Process for Documentation; (4) Quality Control Standards and Process for Judgment/Remediation;
(5) Quality Control Standards and Process for Reporting; (6) Quality Control Standards and Process for Vendor
Management; (7) PFI Standards; (8) PFI Rating Methodology; (9) Servicing; (10) PFI Training; and (11)
Governance.




         Federal Housing Finance Agency Office of Inspector General • ESR-2014-007 • April 22, 2014
                                                         5
platform upon which risk management groups may work collaboratively to improve performance
reporting, tracking, and PFI support. For example, future onsite training will be customized for
each PFI in that it will be directed toward the resolution of issues identified during recent quality
control assessments of the institution.

Officials from the FHLBank of Chicago regularly meet with FHFA to discuss their progress in
implementing the MPF Risk Framework, and FHFA expects it to be fully operational by July
2014.

Conclusion

Although there are unresolved issues related to the FHLBank of Chicago’s quality assurance
process, we found that FHFA has been actively overseeing the FHLBank of Chicago’s
remediation efforts. Thus, we conclude that FHFA’s oversight of the MPF Xtra program is not
ripe for evaluation at this time. We will monitor developments in the MPF Xtra program and
initiate future work on this topic as necessary.

Scope and Methodology

The purpose of this memorandum was to assess FHFA’s oversight of the MPF Xtra program.

To achieve this objective, we reviewed publicly available information regarding the MPF Xtra
program. We interviewed FHFA officials and FHLBank of Chicago management officials. We
also obtained and reviewed documents and data from FHFA, the FHLBank of Chicago, and
Fannie Mae. These included risk assessments, contracts, and loan defect rate data. Using
publicly available data, we calculated the MPF Xtra program as a percent of the FHLBank of
Chicago’s total member-focused business; and we also calculated the percent of MPF Xtra loans
that make up Fannie Mae’s single-family loan acquisitions. We did not independently test the
reliability of the data.

Our work was conducted under the authority of the Inspector General Act and in accordance
with the Council of the Inspectors General on Integrity and Efficiency’s Quality Standards for
Inspection and Evaluation (January 2012). These standards require us to plan and perform a
survey that results in evidence sufficient to support reasonably the conclusions made herein. We
believe that the conclusions contained in this memorandum meet this standard.

The performance period for this survey was from September 2013 to March 2014.

This survey was led by Investigative Counsels Adrienne Freeman and Alexa Strear. Assistance
was provided by David P. Bloch, Director, Division of Mortgage, Investments, and Risk
Analysis; and Angela Choy, Director, Division of Fraud Prevention and Program Management.




     Federal Housing Finance Agency Office of Inspector General • ESR-2014-007 • April 22, 2014
                                                  6
We appreciate the cooperation of FHFA, the FHLBank of Chicago, and Fannie Mae staff, as well
as the assistance of all those who contributed to the preparation of this report. It has been
distributed to Congress, the Office of Management and Budget, and others and will be posted on
OIG’s website, www.fhfaoig.gov.

cc:    Melvin L. Watt, Director
       Richard Hornsby, Chief Operating Officer
       John Major, Manager, Internal Controls and Audit Follow-Up




      Federal Housing Finance Agency Office of Inspector General • ESR-2014-007 • April 22, 2014
                                                  7
Additional Information and Copies

For additional copies of this report:

         Call: (202) 730-0880

         Fax: (202) 318-0239

         Visit: www.fhfaoig.gov

To report alleged fraud, waste, abuse, mismanagement, or any other kind of criminal or
noncriminal misconduct relative to FHFA’s programs or operations:

         Call: (800) 793-7724

         Fax: (202) 318-0385

         Visit: www.fhfaoig.gov/ReportFraud

         Write:
                   FHFA Office of Inspector General
                   Attn: Office of Investigation – Hotline
                   400 Seventh Street, S.W.
                   Washington, DC 20024




      Federal Housing Finance Agency Office of Inspector General • ESR-2014-007 • April 22, 2014
                                                  8