oversight

Evaluation of FHFA's Oversight of Fannie Mae's Transfer of Mortgage Servicing Rights from Bank of America to High Touch Servicers

Published by the Federal Housing Finance Agency, Office of Inspector General on 2012-09-18.

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

          FEDERAL HOUSING FINANCE AGENCY
            OFFICE OF INSPECTOR GENERAL

          FEDERAL HOUSING FINANCE AGENCY
            OFFICE OF INSPECTOR
             Evaluation             GENERAL
                        of FHFA’s Oversight of
     Fannie Mae’s Transfer of Mortgage Servicing Rights
       from Bank of America to High Touch Servicers




EVALUATION REPORT: EVL-2012-008         DATED: September 18, 2012
                                            AT A GLANCE
                                          title Transfer of Mortgage Servicing Rights
 Evaluation of FHFA’s Oversight of Fannie Mae’s
                    from Bank of America to High Touch Servicers

Why FHFA-OIG Did This Evaluation                                An internal audit conducted by Fannie Mae raised
The Federal Housing Finance Agency (FHFA or
                                                            titlequestions about the controls surrounding the High Touch
                                                           title
Agency) Office of Inspector General (FHFA-OIG)                  Servicing Program, as well as the likelihood that it would
conducted this evaluation to assess FHFA’s oversight of         achieve the projected savings. Similarly, FHFA-OIG
a transaction between the Federal National Mortgage             found that Fannie Mae relied on a single consultant to
Association (Fannie Mae) and Bank of America (BOA).             price most of the MSR transactions under the program,
In the summer of 2011, Fannie Mae proposed to                   and that the terms of Fannie Mae’s standard servicing
purchase from BOA – for $512 million – the mortgage             contract appear to constrain its ability to transfer – at no
servicing rights (MSR) to approximately 384,000                 or reduced cost – MSR for reasons related to a portfolio’s
mortgage loans owned or guaranteed by Fannie Mae.               performance.
The deal between Fannie Mae and BOA received                    Furthermore, FHFA-OIG determined that FHFA can
significant public and media attention; indeed, FHFA-           improve its oversight of Fannie Mae’s program. Although
OIG received a request from Congress that it review             FHFA reviewed the BOA transaction and allowed it to
the transaction.                                                proceed, it did not conduct similar reviews of other
                                                                transactions in the High Touch Servicing Program nor did
What FHFA-OIG Found                                             it review the program as a whole.
Fannie Mae’s purchase of MSR from BOA was not an
isolated event. Rather, it was the most recent of               What FHFA-OIG Recommends
several transactions executed as part of an ongoing             FHFA-OIG recommends that FHFA: (1) consider
initiative. This initiative, the High Touch Servicing           revising its Delegation of Authorities to the Enterprises to
Program, utilizes specialty servicers who work with             require FHFA approval of unusual or high cost new
at-risk borrowers to help reduce the number of                  initiatives; (2) ensure that Fannie Mae applies additional
defaults in mortgages owned or guaranteed by Fannie             scrutiny and rigor to pricing significant MSR transactions;
Mae. In order to transfer MSR from a regular servicer           (3) review the assumptions underlying the High Touch
to a specialty servicer, Fannie Mae must first terminate        Servicing Program and, as the program develops, re-
the regular servicer’s contract, i.e., purchase or              evaluate the performance criteria for the program; and
otherwise take away the MSR.                                    (4) ensure that Fannie Mae fully implements earlier FHFA
The BOA transaction was the largest of the transfers in         directions on the purchase and transfer of MSR; this could
the High Touch Servicing Program to date. However,              include revising its standard servicing contract to facilitate
the amount Fannie Mae paid was consistent with the              MSR transfers due to portfolio performance.
amounts it had paid to other servicers from which it
purchased MSR under the program.




Evaluation Report: EVL-2012-008                                                           Dated: September 18, 2012
TABLE OF CONTENTS
TABLE OF CONTENTS ................................................................................................................ 3
ABBREVIATIONS ........................................................................................................................ 5
PREFACE ....................................................................................................................................... 6
BACKGROUND ............................................................................................................................ 7
      I. Introduction ......................................................................................................................... 7
             A. FHFA and Its Delegation of Authorities to the Enterprises ........................................ 7
             B. About Fannie Mae and the Secondary Mortgage Market ............................................ 8
             C. Mortgage Servicing ..................................................................................................... 8
             D. The Housing Crisis .................................................................................................... 10
      II. Fannie Mae’s Mortgage Servicing Strategy..................................................................... 11
             A. Potential Limitations in the Standard Servicing Arrangement .................................. 12
             B. The High Touch Servicing Advantage ...................................................................... 12
      III. The Bank of America Transaction .................................................................................. 16
             A. Fannie Mae and BOA Negotiate the Price of the MSR ............................................. 16
             B. Fannie Mae’s Independent Valuation ........................................................................ 17
             C. FHFA Reviews and Approves the BOA MSR Transaction ...................................... 20
      IV. Fannie Mae’s Internal Audit of the High Touch Servicing Program ............................. 22
             A. Preliminary Assessment of the High Touch Servicing Program ............................... 23
             B. The Internal Audit’s Findings .................................................................................... 23
             C. Projected Credit Loss Savings ................................................................................... 24
      V. The High-Touch Servicing Program to Date ................................................................... 25
FINDINGS .................................................................................................................................... 27
      1. The BOA Transaction Was Part of a Larger, Essentially Sound Initiative ...................... 27
      2. The BOA Portfolio Purchase Was Consistent with Similar Transactions ........................ 27
      3. Fannie Mae’s Ability to Transfer MSR on Favorable Terms Is Constrained by
         Its Servicing Contract ....................................................................................................... 27


          Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
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      4. The High Touch Servicing Program Would Benefit from a More Rigorous
         Valuation Process.............................................................................................................. 27
      5. FHFA’s Oversight of the High Touch Servicing Program Was Limited ......................... 27
CONCLUSION ............................................................................................................................. 28
RECOMMENDATIONS .............................................................................................................. 28
OBJECTIVE, SCOPE, AND METHODOLOGY ........................................................................ 30
APPENDIX A ............................................................................................................................... 31
ADDITIONAL INFORMATION AND COPIES ........................................................................ 35




          Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
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ABBREVIATIONS
BOA ....................................................................................................................... Bank of America
Bps ................................................................................................................................. Basis Points
CEO............................................................................................................. Chief Executive Officer
DCF ................................................................................................................... Discount Cash Flow
ESP...................................................................................................... Enhanced Servicing Program
Enterprises.......................................................................................... Fannie Mae and Freddie Mac
Fannie Mae......................................................................... Federal National Mortgage Association
FHFA or the Agency.................................................................... Federal Housing Finance Agency
FHFA-OIG ..................................... Federal Housing Finance Agency, Office of Inspector General
Freddie Mac .................................................................. Federal Home Loan Mortgage Corporation
The Guide.................................................................. Fannie Mae’s Single Family Servicing Guide
HAMP ...............................................................................Home Affordable Modification Program
HERA.......................................................................Housing and Economic Recovery Act of 2008
MBS ..................................................................................................... Mortgage-Backed Securities
MRA ...................................................................................................... Matter Requiring Attention
MSR ....................................................................................................... Mortgage Servicing Rights




          Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                                        5
                                       Federal Housing Finance Agency
                                         Office of Inspector General
                                               Washington, DC



                                                 PREFACE
FHFA-OIG was established by the Housing and Economic Recovery Act of 2008 (HERA),
which amended the Inspector General Act of 1978. FHFA-OIG is authorized to conduct audits,
evaluations, investigations, and other activities of the programs and operations of FHFA; to
recommend policies that promote economy and efficiency in the administration of such programs
and operations; and to prevent and detect fraud and abuse in them.

This evaluation is one in a series of audits, evaluations, and special reports published as part of
FHFA-OIG’s oversight responsibilities. It furthers FHFA-OIG’s first strategic goal: assisting
FHFA to improve the economic health of the regulated entities and to understand the causes and
costs of the conservatorships. Specifically, it is intended to assess FHFA’s supervision of Fannie
Mae’s acquisition of mortgage servicing rights from BOA and to identify opportunities for
improvement generally.

This evaluation was led by Director of Special Projects David Z. Seide. The report was prepared
by Assistant Inspector General David Morgan Frost, with assistance from Chief Economist
Simon Wu. FHFA-OIG appreciates the assistance of all those who contributed to this report.




George Grob
Deputy Inspector General for Evaluations




        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            6
BACKGROUND
I. Introduction

In July 2011, Fannie Mae negotiated an agreement to pay $512 million to BOA to acquire the
MSR to approximately 384,000 mortgage loans that were owned or guaranteed by the Enterprise.
The deal, which ultimately cost $421 million,1 received significant attention in the media and by
Members of Congress. Indeed, within a month of the sale, FHFA-OIG received a letter from
Representatives Jackie Speier, George Miller, Brad Miller, and Maxine Waters, requesting that it
review the BOA transaction.

In this report, OIG reviews and evaluates Fannie Mae’s business rationale for its deal with BOA,
the circumstances surrounding that transaction, similar transactions with several other banks, and
the supervisory role played by FHFA.

A. FHFA and Its Delegation of Authorities to the Enterprises
HERA established FHFA as the federal safety and soundness and mission regulator for Fannie
Mae, the Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal Home Loan
Banks.

Since September 2008, FHFA has also acted as the conservator for Fannie Mae and Freddie Mac
(collectively, the Enterprises), in which capacity it has plenary authority over all Enterprise
operations. FHFA carries out its oversight and conservatorship responsibilities by conducting
continuous supervision and targeted examinations and by issuing supervisory or enforcement
orders.

On November 24, 2008, FHFA issued orders delegating most Enterprise management functions
to the Enterprises’ boards of directors. FHFA advised the Enterprises that they “should consult
with and obtain approval of the Conservator” before taking action in certain specific areas,
including significant settlements; matters relating to the conservatorship; matters involving




1
  The amount initially proposed by Fannie Mae to FHFA for the transaction was $512 million for the MSR to
approximately 384,000 loans. At the time of the first transfer, the projected total value was $496.3 million. When
all transfers were completed, the total amount paid by Fannie Mae was $421 million. The decrease was the result of
a reduction in the number of loans in the portfolio – and the corresponding reduction in the unpaid principal balance
of the portfolio – due to early payoffs or refinancings.


        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
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reputational risk; and any substantial transaction between an Enterprise and any of its affiliates,
except for transactions undertaken in the ordinary course of business.2

Matters not specified in the delegations as requiring the conservator’s approval are typically
handled by the Enterprises without first seeking such approval. FHFA relies on the Enterprises
to determine, in light of the delegations, which matters require conservator approval and which
may be considered within the ordinary course of business. Because the Enterprises’
interpretations of their delegations are not formally reviewed by the conservator, they tend to be
final.

B. About Fannie Mae and the Secondary Mortgage Market
Fannie Mae was chartered by Congress to create liquidity and promote affordable housing in the
mortgage market (i.e., to provide the ready availability of cash for mortgages). To carry out this
mission, Fannie Mae purchases mortgage loans originated by banks and other lenders, enabling
those institutions to replenish their funds so they can lend to other homeowners.

Fannie Mae purchases mortgages on single-family homes from mortgage companies,
commercial banks, credit unions, and other financial institutions. Fannie Mae generally
securitizes these mortgages by bundling them into mortgage-backed securities (MBS), which it
then sells to investors. When homeowners make their payments of mortgage principal and
interest each month, these payments are ultimately transferred (passed through) to MBS
investors.

A significant portion of Fannie Mae’s MBS business involves guaranteeing the underlying
mortgages securitized by Fannie Mae. In exchange for a “guarantee fee,” Fannie Mae assumes
the risk for all principal and interest payments on the security. Thus, Fannie Mae bears the credit
risk in the event of a borrower’s default.

C. Mortgage Servicing
Regardless of whether a loan is sold, securitized, or retained in a lender’s portfolio, the mortgage
itself must be “serviced.” This means that payments must be collected and disbursed
appropriately and the loan must be administered, including the release of the mortgagor’s interest
2
  See Letter from James B. Lockhart, III, Director, FHFA, to Chairman of the Board Philip A. Laskawy (Nov. 24,
2008), and Letter from James B. Lockhart III, Director, FHFA, to John A. Koskinen, Chairman of the Board (Nov.
24, 2008). In addition, the Enterprises are required to consult with FHFA on certain other specified matters,
including: actions involving capital stock and dividends; the creation of any subsidiary or affiliate; matters
involving hiring, compensation, and termination benefits of directors and officers at the executive vice president
level and above; the retention and termination of external auditors and law firms serving as board consultants;
settlements in excess of $50 million of litigation, claims, regulatory proceedings, or tax-related matters; or mergers
or acquisitions of businesses involving consideration in excess of $50 million.


        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            8
in the borrower’s collateral at payoff or, as necessary, the management of defaults and
foreclosures.

Although both Enterprises purchase substantial numbers of loans, neither services any of the
loans in its portfolio. Rather, the Enterprises rely on third-parties to service their loans; these
third parties generally are affiliates of the parties that originated and sold the loans. The
following figure illustrates the relationship between servicers, the Enterprises, and homeowners.

                                Figure 1: The Mortgage Servicing Process




For this work, servicers generally receive an annual loan servicing fee. Typically, the fee is
calculated based on the percentage of the unpaid principal balance of a particular loan. Fannie
Mae pays regular or standard loan servicers a minimum annual fee of 25 basis points (bps), or
one quarter of one percent, on the unpaid principal balance of performing loans, although the
actual fee may be higher.3 Specialty servicers receive a fixed amount (figured in dollars per year
3
  The “net servicing fee” for a loan may exceed 25 bps, depending on a number of factors, such as MBS pass-
through (the yield on the particular MBS of which the loan is a part) and Fannie Mae’s guarantee fee (which varies).
Consider the case of a particular loan with a 6% interest rate, a guarantee fee of 20 bps, and an MBS pass-through of
5.5%. To calculate the net servicing fee, Fannie Mae would take the yield of the loan (6% or 600 bps) and subtract:
(1) the yield of the security (5.5% or 550 bps); (2) the guarantee fee (20 bps); and (3) the minimum service fee (25
bps). The remaining sum (5 bps) would then be added to the 25 bps minimum net service fee. Thus, in this case,
the annual fee that a servicer would claim for this particular loan would be 30 bps or 0.30%. Fannie Mae’s service
fees are not negotiated but are calculated based on this fixed formula; a standard servicer’s ability to make a profit
will vary with its ability to economize on servicing activities.


        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
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per loan) that varies depending on the status of the loan. In such cases, fees would typically rise
for loans that are delinquent, in light of the additional work that the servicer would have to
perform (e.g., working with delinquent borrowers to facilitate payments or managing any
foreclosures).

The terms of the loan servicing arrangement between Fannie Mae and its loan servicers are
found in the Fannie Mae Single Family Servicing Guide (the Guide).4 Under its terms, Fannie
Mae may transfer MSR from one loan servicer to another, with or without cause. If servicers are
terminated for cause, then Fannie Mae pays no termination fee. On the other hand, if Fannie
Mae decides to use the services of another servicer and terminates a servicer without cause, then
the Guide specifies that Fannie Mae must pay a fee to the terminated servicer equivalent to twice
its annual servicing fee on each loan serviced.

In other words, if Fannie Mae wanted to transfer servicing without cause on loans for which the
servicer is paid 25 bps, then Fannie Mae could do so provided it paid the servicer a termination
fee on each loan to be transferred. In that case, the termination fee would be 50 bps multiplied
by the unpaid principal balance of all of the loans serviced. That figure could be significant,
especially where, as here, Fannie Mae transferred hundreds of thousands of loans to another
servicer.

In addition, when Fannie Mae transfers MSR without cause, the Guide provides the terminated
servicer with the opportunity to attempt to find another buyer willing to pay more than the
contractual termination fee. Specifically, the servicer is entitled to up to 90 days to sell the MSR
to another purchaser.

D. The Housing Crisis
With the collapse of the housing market, default rates on single-family mortgages increased
dramatically, particularly for loans originated during the housing boom and shortly thereafter
(2005–2008). As reflected in Figure 2 below, by 2011, over 5% of the single-family mortgages
originated in 2005 were in default; over 8.5% of mortgages from 2006 and approximately 9% of
mortgages from 2007 were also in default. Moreover, the chart reveals that defaults peak several
years after origination.




4
  Fannie Mae Single Family 2012 Servicing Guide (March 14, 2012) (online at
https://www.efanniemae.com/sf/guides/ssg/svcgpdf.jsp).


        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
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                  Figure 2: Fannie Mae Single-Family Cumulative Default Rates5
    Cumulative Default Rates of Single-Family Conventional Guaranty Book of Business by Origination Year




Fannie Mae has sustained – and continues to sustain – significant losses on defaulting mortgages.
From the third quarter of 2008 (the quarter in which Fannie Mae was placed in conservatorship)
through the end of 2011, Fannie Mae lost more than $157 billion; most of these losses were
attributable to mortgage losses in the Enterprise’s retained and guaranteed mortgage portfolios.

II. Fannie Mae’s Mortgage Servicing Strategy

In late 2008, as a result of Fannie Mae’s review of its mortgage servicing processes, the
Enterprise began a project to manage servicing differently in an effort to mitigate the credit
losses impacting its portfolio of mortgage investments. One of the ideas the Enterprise
contemplated was the acquisition of a company through which it could conduct its own mortgage
servicing (effectively saving costs by eliminating the “middle man”). Fannie Mae proposed this
idea to FHFA; however, the idea was not implemented. Accordingly, with continuing concerns
as to servicing issues, Fannie Mae sought other means of realizing credit loss savings on its
troubled mortgage portfolio.



5
    Source: Fannie Mae 2011 Credit Supplement (Feb. 29, 2012).


          Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
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As part of this effort, Fannie Mae established the Enhanced Servicing Program (ESP). Enhanced
servicing involves closer and more frequent contact between a delinquent mortgagor and the
servicer; it is the business model utilized by so-called “specialty” or “high touch” servicers.

A. Potential Limitations in the Standard Servicing Arrangement
Prior to the inception of ESP, Fannie Mae may have had (what one of its executives described
as) a “misalignment of interests” with its servicers. As guarantor or loan holder, Fannie Mae
could face significant losses from a default. However, a servicer earns only a fraction of a
percent of the unpaid balance of a mortgage it services and, thus, the fees derived from any
particular loan may not – at least for the servicer – provide adequate incentive to undertake
anything more than the bare minimum of effort in order to prevent a default. This will typically
include sending out delinquency notices to borrowers who have not made timely payments,
telephoning delinquent borrowers, and, ultimately, initiating foreclosure proceedings.

B. The High Touch Servicing Advantage
Fannie Mae determined that specialty servicers might be able to improve outcomes for
mortgages at risk of default. These servicers intensively contact borrowers, educate them on the
impact of not paying, and explain options to avoid foreclosure. A specialty servicer will often
have a single point of contact for a delinquent borrower; this individual is responsible for
outreach services. Moreover, Fannie Mae mandates certain staffing levels for high touch
servicers, limiting the number of cases any staffer can handle.

As an incentive for providing an enhanced level of attention to high risk loans, specialty
servicers have a different compensation structure from the one applicable to standard servicers.
As indicated above, a standard servicer’s compensation is based on a fraction of a percent of the
unpaid balance of a particular loan – the fraction is small enough that it may not be cost-effective
for the servicer to expend significant resources to prevent default. A specialty servicer’s
compensation, however, generally comes in three forms: first, the specialty servicer receives
base fees; second, it receives incentive payments for mortgage modifications; and, finally, it
receives a performance payment based on its success as contrasted with that of a comparable (or
“benchmark”) portfolio established by Fannie Mae. Accordingly, a specialty servicer’s
compensation varies far more directly and significantly with its ability to prevent defaults. This
may reduce the “misalignment of interests” the Fannie Mae executive noted with its standard
servicers.




        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
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         The High Touch Servicing Program
         The Origin of the High Touch Servicing Program
Fannie Mae’s High Touch Servicing Program originated with the consolidation of various
servicing-related initiatives, including ESP. The team responsible for ESP had determined that
approximately 70% of Fannie Mae’s mortgage losses were coming from a specific portfolio of
mortgages with a combined principal balance of approximately $300-$400 billion.

Having pinpointed the source of so large a portion of its losses, Fannie Mae concluded that
transferring the MSR for this portfolio of mortgage investments to specialty servicers could
potentially help avoid substantial anticipated credit losses. Under the plan, Fannie Mae would
terminate its contracts with the servicers who held MSR associated with the problematic
portfolio and select specialty servicers whose efforts, Fannie Mae anticipated, would generate
substantial cost savings. According to Fannie Mae, the High Touch Servicing Program could
result in credit loss savings in the range of 20% – a potentially significant amount given the
credit losses Fannie Mae expected to sustain on its higher risk mortgages.

According to a Fannie Mae executive, prior to 2009, Fannie Mae occasionally had transferred
MSR; however, this was generally done as a result of poor financial practices on the part of a
servicer or some impairment to a servicer’s financial ability or its likely capacity to continue
servicing the mortgages. Fannie Mae typically had not transferred MSR as a strategic move to
improve the return on its investments. Thus, although the notion of an MSR transaction was not
new to Fannie Mae, the basic concept of the High Touch Servicing Program – a planned series of
MSR transactions designed to reduce credit losses through specialty servicing – was a novel
concept.

In light of this, in early to mid-2009, the executives responsible for the High Touch Servicing
Program presented the business case for the program to Fannie Mae’s Chief Executive Officer
(CEO), who approved it.6 Fannie Mae provided briefings to FHFA on the High Touch Servicing
Program; however, Fannie Mae did not seek FHFA’s approval to undertake the program prior to
its initiation, nor did it seek such approval after the program was initiated, apparently concluding
that the program did not fall within any category of activity requiring prior approval from FHFA
in its role as conservator. Fannie Mae has asserted that the program itself and the individual
transactions fell within Fannie Mae’s ordinary course of business, and thus remained within the
authority FHFA had delegated to Fannie Mae in November of 2008.



6
  The first transaction in the program actually was completed on November 30, 2008, months prior to the CEO
formally approving the program.


        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
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         The High Touch Servicing Program Gets Underway
Initial activities under Fannie Mae’s new program involved the Enterprise’s financing a portion
of MSR acquisitions by specialty servicers, who acquired the MSR on specified numbers of
loans from standard servicers. Later, Fannie Mae paid a portion of the purchase price directly to
the terminated servicers and contracted with specialty servicers to manage servicing activities.

Prior to the BOA transaction in August 2011, Fannie Mae had conducted or facilitated MSR
transactions with about twelve other standard servicers pursuant to the High Touch Servicing
Program. With these transactions, Fannie Mae transferred to specialty servicers MSR for over
700,000 higher-risk loans with an unpaid balance in excess of $130 billion. Fannie Mae paid, or
financed the payment of, approximately $1.5 billion in termination fees (including the BOA
transaction) for the MSR it transferred.

         FHFA Examiners Question the Amounts Paid by Fannie Mae to Transfer MSR
Beginning in October 2010 and continuing through early 2011, FHFA, in its capacity as
regulator of Fannie Mae, reviewed the Enterprise’s administration of the Home Affordable
Modification Program (HAMP).7 During the course of that review, the examination staff learned
that Fannie Mae was paying “significantly more than the contractual or going rate” to transfer
MSR.

On June 13, 2011, following its review, FHFA issued a report expressing serious concerns about
HAMP generally. With respect to MSR specifically, FHFA found that “Fannie Mae’s approach
to transferring non-performing loans from servicers for poor performance is inadequate.”8
FHFA’s report included a matter requiring attention (MRA), in which FHFA observed that
Fannie Mae had facilitated the transfer of MSR through negotiated transactions and had routinely
paid more than the contractually specified fee for terminations without cause. Specifically, the
MRA stated that Fannie Mae’s third-party sales of servicing rights in 2008 through 2010
revealed a flawed approach to servicing transfers and indicated that Fannie Mae was paying a
premium to transfer MSR from servicers who failed to service the loans at an acceptable level.

FHFA noted that Fannie Mae had facilitated third-party sales of servicing rights in 2008 and
2009, and transferred servicing rights in 2010. The cumulative effect of these actions was to

7
  HAMP is a federal government-sponsored program designed to provide homeowners an opportunity to modify
their loans to more affordable monthly payments.
8
 FHFA-OIG notes that insofar as “performance” is concerned, although BOA’s performance was below average
among its peer group, it was never alleged to have been in breach of its contract with Fannie Mae. Rather, in the
wake of the financial crisis, it appears that Fannie Mae realized that the standard servicing model contracted for
between BOA and Fannie Mae no longer met Fannie Mae’s requirements for a high risk portfolio.


        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
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transfer the servicing of 741,000 loans with $131.45 billion in unpaid principal balance. FHFA
stated, however, that in each instance Fannie Mae made the servicer whole for loans transferred,
thus eliminating any punitive effect of the transfer.

According to FHFA, in instances where Fannie Mae had opportunities to move loans “without
cause” at a lower rate, this option was not exercised. For example, FHFA noted a transaction in
which Fannie Mae had the opportunity to transfer servicing at twice the net service fee, but
settled at 2.77 to 2.87 times the net service fee. FHFA stated that such transactions not only
failed to encourage improved servicer performance, but actually encouraged and even rewarded
poor performance. FHFA concluded:

         We expect Fannie Mae to structure its portfolio transfers in a manner that reflects
         the performance deficiencies of the transferring servicer. Specifically, if the
         transfer is a result of poor servicer performance, the transaction will not make the
         servicer that failed to perform whole.

By letter dated July 13, 2011, Fannie Mae disagreed with FHFA’s conclusion and argued that, in
most instances, it had paid for MSR transfers at an appropriate rate. It also stated that, in light of
the:

         high risk nature of the portfolios and disproportionate share of expected future
         losses relative to the entire Single Family portfolio … it was in Fannie Mae’s best
         interest to negotiate mutually beneficial terms in order to gain control of servicing
         and therefore, credit performance of the assets.

Fannie Mae added that any attempt to transfer MSR without proper compensation would have
resulted in litigation as well as unnecessary and costly delays. Finally, Fannie Mae asserted that,
from a business perspective, a negotiated settlement was a better choice, as follows.

         Servicing transfers are operationally intensive. Cooperation and coordination
         between the existing and new servicer therefore is critical. If we had not
         negotiated on price, the existing servicers would have not cooperated, thereby
         impacting credit losses, the borrower, and the new servicer’s ability to service.

FHFA examiners, however, were not persuaded by Fannie Mae’s response, as discussed in
further detail below. Meanwhile, as discussions on the MRA continued between Fannie Mae and




        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
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FHFA,9 the High Touch Servicing Program continued apace and Fannie Mae negotiated the
BOA transaction, the largest transaction in the history of the program.

III. The Bank of America Transaction

Fannie Mae had identified within the portfolio of loans that it owned or guaranteed
approximately 384,000 higher risk loans serviced by BOA with a combined unpaid principal
balance of approximately $73.6 billion. The portfolio’s delinquency rate was approximately
11%, and Fannie Mae had calculated that, under BOA’s servicing paradigm, defaults on
mortgages in the portfolio would result in credit losses of approximately $10.9 billion.10

Conversely, Fannie Mae, as part of its High Touch Servicing Program, had also projected that
were this portfolio to be transferred to specialty servicers, the Enterprise could realize credit loss
savings ranging from approximately $1.7 billion to $2.7 billion over the subsequent five years.
Accordingly, around January of 2011, Fannie Mae commenced discussions with BOA with the
intention of purchasing the MSR from BOA and transferring them to a specialty servicer.11

A. Fannie Mae and BOA Negotiate the Price of the MSR
As indicated above, Fannie Mae’s servicing contract provides two primary methods of
terminating a servicer’s MSR in order to transfer them to another servicer – “for cause” or
“without cause.” Fannie Mae could transfer MSR “for cause” without any termination fee;
should it elect to transfer MSR “without cause,” however, its servicing contract calls for payment
to the servicer of an amount equal to twice the annualized servicing fee. Additionally, in the
event that MSR were to be transferred “without cause,” the servicer would have the opportunity,
for 90 days, to attempt to find another buyer for the MSR.

BOA received a net servicing fee of 29 bps on the portfolio in question. Thus, according to the
Guide, termination of BOA’s servicing contract “without cause” should have resulted in a
payment in the amount of 58 bps (0.58%) of the $73.6 billion unpaid principal balance of the
loans. If Fannie Mae had chosen this option, the transfer fee would have been about $427
million, $85 million less than the actual negotiated price. As detailed below, the parties

9
  Subsequently, by letter dated October 26, 2011, Fannie Mae agreed to update internal policies regarding servicing
transfers and other aspects of the Guide.
10
   Fannie Mae reviewed BOA’s overall servicing performance and concluded that it was below average in relation
to BOA’s servicer peer group, but the Enterprise never determined the servicer to be in breach of its contract.
Fannie Mae also noted that BOA had brought in new management to handle servicing, but improvements in the
process were likely to take some time.
11
   Fannie Mae had initially broached the subject with BOA in early 2010; however, the parties were too far apart on
the price of the termination fee.


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ultimately reached an agreement to transfer the portfolio for $512 million, a sum equal to 2.4
times the annualized servicing fee.

Initially, BOA demanded a fee of 84 bps (about $621 million). Under the servicing contract,
BOA had the right to delay a “without cause” transfer for up to 90 days while it sought another
buyer. BOA may or may not have been able to find a buyer willing to pay more than 58 bps for
its MSR; nonetheless, BOA may well have recognized that the prospect of a three month delay in
the transaction (and the attendant additional delay and expenses that it would cause Fannie Mae)
provided it some leverage in the negotiations.

In preparation for the proposed transaction – as for most other transactions in the High Touch
Servicing Program – Fannie Mae engaged an independent valuation firm (the “independent
valuator”) to provide an assessment of the value of the BOA portfolio. Fannie Mae did not seek
any other independent valuations of the portfolio.

B. Fannie Mae’s Independent Valuation
At Fannie Mae’s direction, the independent valuator produced a valuation analysis of the BOA
MSR portfolio. The independent valuator arrived at its market valuation through a common
valuation technique, discounted cash flow (DCF) analysis.

The DCF analysis calculates the value of an asset today, based on projections of how much
money the asset is going to make in the future. A key element of DCF analysis is the discount
rate, which is the interest rate used to estimate the present value of future cash flows. In the case
of a portfolio of mortgages, for example, the greater the risk of defaults, refinancings, or other
diminutions of future payments (i.e., decreases in the unpaid principal balance of the mortgage
portfolio and, consequentially, reduction of annual payments for servicing), the higher the
discount rate; alternatively, the lower the risk of diminutions of future payments, the lower the
discount rate.

The independent valuator concluded that the weighted average discount rate for its market
analysis was 15.3%. That figure produced a market value of 63 bps, or $464 million, for the
BOA portfolio – $37 million more than what the contract specified the fee would be had BOA
been terminated without cause (i.e., 58 bps, or $427 million).12 Had the discount rate been


12
   The independent valuator also provided several additional value measures: the contract termination fee of twice
the annual servicing fee (58 bps, or $427 million); BOA’s publicly stated value for this portfolio (80-90 bps, or $589
million to $663 million); the estimated value that BOA assigned to this MSR on its own books and records (around
84 bps, or $621 million); the intrinsic value of the portfolio to Fannie Mae, meaning the amount it internally valued
the portfolio (61.5 bps, or $453 million); and the range of values negotiated between Fannie Mae and BOA (66-69.5
bps, or $486 million to $512 million). Thus, the range of values the independent valuator presented went from a low


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higher, then the valuation would have been lower; conversely a lower and less risky discount rate
would have resulted in higher valuation.

          1. Possible Issues with Using a Single Valuation
The independent valuator calculated the 15.3% discount rate by assigning varying discount rates
to different groups of loans in the BOA portfolio. The independent valuator assigned discount
rates based on a variety of factors that contribute in different ways to the risks inherent in any
particular loan.13 However, independent assessments of the valuation, one commissioned by
FHFA-OIG and another conducted by FHFA-OIG’s Chief Economist, raise two questions about
the 15.3% discount rate: first, whether the valuation adequately accounted for regional variation
and negative equity severity, given the heavy concentration of severely underwater loans
originated in the states hardest hit by the housing crisis; and second, whether the valuation
adequately accounted for recent MSR transactions, a number at levels noticeably lower than the
Fannie Mae-BOA negotiated price.

          Regional Variation
Of the 384,000 loans covered by the BOA transaction, about 60% are concentrated in the five
states hardest hit by the housing crisis: California, Florida, Arizona, Nevada, and Michigan. The
drop in property values in those states was precipitous – by May 2011, property values in Los
Angeles, California, had dropped 38.1% from their June 2006 peak value; property values in Las
Vegas, Nevada, had dropped 59.1%, and property values in Miami, Florida, had dropped 50.2%.
Contrast this with property values in Dallas, Texas, which dropped only 8.2% between June
2006 and May 2011, or Denver, Colorado, where properties dropped 11.1% in that time period.

                             Figure 3: Regional Variation in Home Values14

                                                                            June 2006‒May 2011
                                           City                                 Drop in Price
                   Chicago, IL                                              33.0%
                   Dallas, TX                                               8.2%
                   Denver, CO                                               11.1%
                   Las Vegas, NV                                            59.1%
                   Los Angeles, CA                                          38.1%

of 58 bps ($427 million, the contractually specified termination fee) to a high of 90 bps ($663 million, BOA’s
estimated public carry value).
13
  Those factors included: length of loan maturity; whether the loans were fixed-rate or adjustable-rate mortgages;
whether the borrowers were delinquent and, if so, the extent of delinquency; whether the loans were “interest-rate
only;” FICO credit scores; and loan-to-value ratio of the mortgage.
14
     Source: S&P Case-Shiller Home Price Indices.


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                   Miami, FL                                                50.2%
                   New York, NY                                             23.5%
                   Washington, DC                                           28.1%



Given this very wide variation, it is likely that two similarly-situated homes – one in Las Vegas
and the other in Dallas – would present different levels of risk to lenders, and therefore different
discount rates. The valuation model utilized by the independent valuator, however, appears not
to have considered the likely impact of geography on the discount rate – a particularly important
consideration in light of the high concentration of BOA loans in hardest hit states, like
California, Nevada, and Florida.15

Regional variation may also have had a significant effect on risk because the foreclosure process
varies from state to state. Some states require court action on a foreclosed home, while other
states allow foreclosure without judicial action.16 Variations in state foreclosure processes are
significant in that some processes are faster and more efficient than others. Since efficiency
varies by state, the timeline for receiving expected future cash flows also varies and the discount
rate used in the DCF may vary. It appears that the independent valuator may not have
considered the possible impact of state foreclosure law on the value of the BOA portfolio.

         Severity of Loans Underwater
The independent valuator attempted to account for the severity of underwater loans somewhat by
dividing the 384,000 BOA loans into two groups: (1) loans not underwater (i.e., loans with loan-
to-value ratios of less than 100%) or barely underwater (i.e., loans with loan-to-value ratios of
greater than 100% and less than 110%); and (2) all other underwater loans (i.e., loans with loan-
to-value ratios of greater than 110%). However, this loan population had a substantial number of
loans that were severely underwater. Indeed, over 203,000 loans – more than half of the loans –
had loan-to-value ratios of greater than 120% and, thus, entirely within the upper threshold of the
independent valuator. These loans were likely more risky (relative to loans that were not or
barely underwater), which would have been reflected in higher discount rates. Moreover, the
valuation may not have adequately accounted for this concentrated risk because it did not




15
  For example, an independent contractor retained by FHFA-OIG determined that the implied discount rate in the
Texas real estate market was 15%, while in the more volatile Nevada market it was 23%.
16
   In states that require judicial foreclosures, a lender must prove in court that the borrower is in default before
initiating foreclosure. Non-judicial foreclosures are based on deeds of trust that enable the trustee to initiate a
mortgage foreclosure sale without having to go to court.


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differentiate among the classes of underwater loans in the independent valuator’s upper
threshold.17

         Other MSR Transactions
FHFA-OIG also considered several other transactions between 2010 and 2012 in which high
touch servicers acquired portfolios of MSR. These transactions ranged in price from a low of 35
bps to a high of 68 bps. Although Fannie Mae’s transaction with BOA was slightly above the
upper end of this range, FHFA-OIG recognizes the limitations inherent in any comparison of the
transaction between Fannie Mae and BOA with “arm’s length” transactions between other
parties. Fannie Mae, as guarantor of the mortgages in the BOA portfolio, faced the prospect of
significant losses were it not to purchase the MSR; thus, the value of the MSR to Fannie Mae
might well have exceeded the value to a purchaser with no such liability.

         2. Fannie Mae’s Reliance on the Independent Valuator
It appears that Fannie Mae relied exclusively on the independent valuator’s valuation of the MSR
portfolio in its negotiations with BOA. Furthermore, as noted by Fannie Mae’s internal audit of
the High Touch Servicing Program, the Enterprise did not avail itself of its internal Model Risk
Oversight Group to assess the independent valuator’s process or conclusions. An FHFA
examiner familiar with the transaction opined that, in light of the size of the BOA transaction,
Fannie Mae should have done this, as well as obtain a second valuation.

Further, FHFA-OIG ventures no findings as to the validity of the independent valuator’s
valuation model or the accuracy of its valuation of the BOA portfolio, as such.18 However,
valuation models may vary. For example, FHFA-OIG’s independent contractor considered the
BOA portfolio and suggested bases for a different (lower) valuation, in light of factors like those
discussed above. Without attempting to decide the precise model that ought to be used in any
given transaction, FHFA-OIG is persuaded that Fannie Mae could benefit by a more rigorous
examination of the methods employed by MSR valuators in order to determine best practices.

C. FHFA Reviews and Approves the BOA MSR Transaction
Fannie Mae and BOA reached a tentative agreement for the purchase of the portfolio of MSR at
a price of 69.5 bps, or $511,665,515. Although this sum is squarely within the independent
valuator’s valuation range, it represents a premium of 11.5 bps (more than $80 million) over the
17
  According to FHFA-OIG’s contractor, the implied discount rate for loans with a loan-to-value ratio of 110% is
21%, and for loans with a ratio of 180% the discount rate is 30%.
18
  As suggested above, an objective valuation of a particular portfolio may not capture the potential value of the
portfolio to Fannie Mae. Ultimately, the amount that a disinterested buyer might give a willing seller for a particular
portfolio may not be the same as the amount that Fannie Mae might be willing to pay.


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58 bps price specified for a without cause termination under Fannie Mae’s servicing contract. In
essence, the premium gave Fannie Mae the ability to avoid a possible 90 day delay in the
transaction and to utilize a specialty servicer of its choice.

Having reached this tentative agreement for the purchase of MSR, Fannie Mae’s High Touch
Servicing Program team prepared an internal memorandum setting forth projected losses on the
BOA portfolio, as well as anticipated credit loss savings from special servicing. The
memorandum, which also presented the independent valuator’s conclusions as to the value of the
MSR, sought internal approval to purchase the BOA MSR at the negotiated price.

During the internal approval process, Fannie Mae determined that it should seek FHFA’s review
and approval of the BOA transaction. The Enterprise’s reason for seeking the Conservator’s
approval for this transaction was based on the potential appearance of the transaction, the
attendant reputational risk, and the MRA discussed above.19

On July 19, 2011, Fannie Mae alerted FHFA staff to the BOA transaction and requested FHFA
approval. FHFA’s initial reaction appears to have been generally supportive insofar as the
transaction itself was concerned. However, several FHFA personnel were concerned by the
$80 million price premium being offered. In one internal e-mail, dated July 22, 2011, an FHFA
senior manager, who was asked to review the proposed transaction, wrote:

         if the threshold question is whether or not to do the transfer, the answer is
         probably yes. But the analysis probably understates the gain to [BOA] from
         getting this stuff off their books, so we might question if they have squeezed
         [BOA] hard enough on the pricing. It looks like doing the deal is better than not
         doing the deal, but there may be room to push for a better price.

In a July 26, 2011, e-mail to an FHFA executive, who was also reviewing the transaction, Fannie
Mae provided four reasons for its decision to pay a premium over the contractually specified
price:

             Operational impacts (BOA might slow the transaction);

             BOA would be given time to seek a better price for the portfolio;



19
   At the end of 2010, Fannie Mae had received approximately $1.3 billion from BOA in settlement of outstanding
repurchase claims over faulty mortgages. Fannie Mae feared that its payment of nearly half a billion dollars to BOA
for MSR would be perceived as taxpayer-funded relief to BOA. In fact, CNN Money, Forbes, and other
publications raised questions as to Fannie Mae’s motivation for the transaction.


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             Insisting on the contractual price of twice the annualized servicing fee might erode
              liquidity in Fannie Mae MSRs (presumably by placing a ceiling on the sale price of
              such MSRs, thus limiting their value to a potential purchaser); and

             There was a potential litigation risk if Fannie Mae were to enforce a contractual
              provision that it had not enforced in the past.

Notwithstanding these arguments, FHFA officials remained skeptical about the price of the
transaction. On July 29, 2011, FHFA officials directed Fannie Mae to attempt to negotiate a
transfer payment that was no more than twice the annual servicing fee of 58 bps. Fannie Mae
complied. However, on August 1, 2011, BOA informed Fannie Mae that it would not go
forward with the transaction on such terms, and that it would attempt to sell the portfolio to
another servicer.

Fannie Mae’s CEO then proposed a compromise to allow the deal to proceed. Under this so-
called “clawback” agreement, Fannie Mae would pay 69.5 bps for the MSR, but BOA would
agree to refund up to 9.5 bps of the purchase price (about $70 million) if Fannie Mae did not
realize credit loss savings of at least 5% from high touch servicing after 5 years.20 BOA
accepted the proposal, and FHFA’s review of the transaction concluded with the Acting
Director’s issuance of a “no objection” letter on August 3, 2011. The Acting Director’s letter
also imposed several conditions for allowing the transaction to proceed, including the following:

             Fannie Mae and BOA would agree on a formula to measure the credit loss savings;

             Fannie Mae would report periodically to its Board of Directors and FHFA on
              performance versus expectations; and

             Fannie Mae would continue to address the MRA.

Having received its conservator’s approval, Fannie Mae proceeded with the transaction.

IV. Fannie Mae’s Internal Audit of the High Touch Servicing Program

The Fannie Mae-BOA transaction became public knowledge in early August 2011. Soon
thereafter, on August 26, 2011, Fannie Mae’s internal auditors announced an audit of the High
Touch Servicing Program.


20
   The determination as to whether the credit loss savings had been realized was to be based on a “shadow” pool of
mortgages (not all of which were serviced by BOA). The default rate of this pool of mortgages would be compared
to the BOA portfolio to be purchased by Fannie Mae and transferred to specialty servicers.


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The audit of the High Touch Servicing Program had originated as a “review” (a survey in less
detail than an audit) in 2010, and was added to the 2011 Fannie Mae internal audit plan as a more
comprehensive, full audit. The audit covered the period from July 1, 2010, through September
30, 2011.21 The report on the High Touch Servicing Program, issued on January 13, 2012,
concludes that the program is in a “high risk” area, and that the controls governing the program
are in need of improvement.

A. Preliminary Assessment of the High Touch Servicing Program
At the time of the report, Fannie Mae had contracted for the transfer of 15 portfolios under the
High Touch Servicing Program (including the BOA portfolio). By the end of 2011, Fannie Mae
had invested approximately $1.5 billion in the program.

For Fannie Mae’s internal auditors, a key question about the High Touch Servicing Program was
the extent to which it was achieving – or is likely to achieve – its goals. The earliest transfer in
the program took place in November 2008; two others took place in the autumn of 2009. All the
rest, including the BOA transaction, took place in 2010 and 2011. As the credit loss savings
were projected to take place over a five year period that has not yet concluded, no final
assessment of the program may be ventured.

However, according to the audit report, the “overall performance of the portfolios” was
considered favorable. Although only one transfer had achieved the anticipated 20% savings,
program management stated that greater savings were likely to come “as portfolios season,” with
“lower or negative credit loss performance” occurring in earlier months.22 The report notes,
nonetheless, that there was insufficient documentation within Fannie Mae’s files from which
auditors could assess the reasonableness of the credit loss savings assumptions. Specifically, the
report found there was “limited documentation and analysis to support the likelihood that the
expected credit loss savings will be achieved based on historical and current performance of the
special servicers.”

B. The Internal Audit’s Findings
The audit report concludes that the controls governing the High Touch Servicing Program are in
need of improvement. Specifically, it notes the following issues as the most significant:

              Documentation and analysis supporting the projections about credit loss savings is
               inadequate. In particular, the report noted that the Guide lacks clarity on the issue of
21
     Thus, it included the BOA transaction.
22
  It should be noted that the “breakeven” point for the transactions in the High Touch Servicing Program was well
under 20%. In most cases, the cost of the MSR transactions could be justified with less than 5% savings.


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              when it was appropriate to terminate a servicer’s contract with cause or pursue a
              negotiated transaction.

             Fannie Mae’s internal reporting regarding the High Touch Servicing Program is
              inconsistent and does not include a comparison of portfolio performance to
              management’s expectation of performance at specific points in time.

             The independent valuator’s valuation model has not been reviewed by Fannie Mae’s
              Model Risk Oversight Group.

             Fannie Mae does not have processes or procedures in place to oversee the specialty
              servicers’ implementation of policies relating to property preservation, quality
              assurance, and internal controls.

Based on those findings, Fannie Mae management agreed to submit the independent valuator’s
model to Fannie Mae’s Model Risk Oversight Group for further evaluation. FHFA-OIG notes
that a similar analysis by this group of the methods used by other MSR valuators could lead to
the discovery of best practices that could improve Fannie Mae’s negotiating position in future
transactions.

C. Projected Credit Loss Savings
Regarding the essence of the High Touch Servicing Program – the projected 20% credit loss
savings – as stated above, Fannie Mae’s internal auditor’s report states that Fannie Mae
presented “limited documentation and analysis to support the likelihood that expected credit loss
savings will be achieved based on historical and current performance of the special servicers.”
FHFA-OIG also identified confusion regarding the basis for the High Touch Servicing Program
team’s savings projection.

Some officials at Fannie Mae stated that the program was intended and expected to achieve a
20% savings for the Enterprise. Consistently, documentation prepared by Fannie Mae makes it
clear that program management had conveyed an understanding to Fannie Mae senior leadership
– and in the case of the BOA transaction to FHFA – that a minimum 20% credit loss savings was
the intended result of the program. Further, Fannie Mae’s internal auditor’s report on the High
Touch Servicing Program explains that Fannie Mae’s goal is to reduce expected credit losses on
transferred portfolios by 20% over a 5-year period. Moreover, documentation submitted to
FHFA in support of the BOA transaction states:

         As part of our credit expense reduction strategies, the net benefit ranges from
         approximately $1.7 billion to $2.7 billion for the high risk portfolio under the



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         proposed structure depending on Credit Save Percentage (20%–30%). Targeted
         Credit Save is at least 20%.

On the other hand, at least one Fannie Mae executive directly connected with the program stated
that the projected 20% credit loss savings was merely one of several “scenarios,” and that other
projections – both higher and lower – were provided as well.

Nonetheless, regardless of whether credit loss savings were adequately documented, FHFA-
OIG’s analysis confirmed that the “breakeven” points for the transactions to date in the High
Touch Servicing Program were well under 20%.23 In most cases, the cost of the MSR
transactions would have been justified with credit loss savings of less than 5%. Time will tell
whether the savings realized overall (i.e., savings accrued on historic and future transactions)
will justify Fannie Mae’s investment in the program.

V. The High-Touch Servicing Program to Date

In September 2011 (shortly after having approved the BOA transaction), FHFA advised Fannie
Mae that its response to the MRA discussed above failed to address the Agency’s concerns.
Pending resolution of these concerns, FHFA stated that “Fannie Mae should not undertake any
further [MSR] transfers until further notice.” Since the BOA transaction, Fannie Mae has not
paid to transfer MSR, pending resolution of this issue.24

However, as indicated above, the High Touch Servicing Program has been operating formally
since late-2009. To date, Fannie Mae has paid approximately $1.5 billion in order to transfer to
specialty servicers the MSR of over 1.1 million mortgages with an unpaid balance of over $200
billion. Fannie Mae has also paid a premium to transfer these loans to high touch servicers. The
average transaction was at 2.3 times the annualized servicing fee for each transaction, which
represents a premium of 15% over the contractually specified fee of twice the annual servicing
fee. The BOA transaction, which was at 2.4 times the annualized servicing fee, was thus not
significantly different from the “typical” High Touch Servicing Program transaction.

As reflected in Fannie Mae’s internal audit report of the program, some early transfers have
proved successful – others, it may be hoped, will prove similarly successful.



23
  Additionally, FHFA-OIG’s independent contractor determined that Fannie Mae’s 20% credit loss savings
projection is reasonable.
24
    FHFA has subsequently interpreted its directive to mean that Fannie Mae may continue to transfer MSR provided
it does not pay a fee.


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However, whether the program’s projected savings will ever be realized remains an open
question. The concerns expressed by FHFA and Fannie Mae’s own auditors as to various
aspects of the program – including the price paid for MSR, the legitimacy of projected savings,
and lack of quality control at specialized servicers – make the question about credit loss savings
all the more pointed.




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FINDINGS
FHFA-OIG finds that:

    1. The BOA Transaction Was Part of a Larger, Essentially Sound
       Initiative
Fannie Mae’s purchase of mortgage servicing rights from BOA was not an isolated deal related
to the well-known $1.3 billion settlement between BOA and Fannie Mae. Rather, it was the
most recent of several transactions that were part of an ongoing initiative – the High Touch
Servicing Program – to mitigate Fannie Mae’s own losses by reducing mortgage defaults and
foreclosures. FHFA-OIG finds that the concept underlying this program is a sound one.

    2. The BOA Portfolio Purchase Was Consistent with Similar Transactions
Although the BOA transaction was the largest of the transfers in the High Touch Servicing
Program, the amount Fannie Mae paid was consistent with the amounts it had paid to other
servicers from which it purchased MSR under the program.

    3. Fannie Mae’s Ability to Transfer MSR on Favorable Terms Is
       Constrained by Its Servicing Contract
The terms of Fannie Mae’s standard servicing contract appear to constrain its ability to transfer –
for no or reduced cost – MSR due to poor portfolio performance.

    4. The High Touch Servicing Program Would Benefit from a More
       Rigorous Valuation Process
Fannie Mae’s internal audit of the High Touch Servicing Program raised questions as to the
controls surrounding the program. Furthermore, Fannie Mae relied on a single consultant to
price most of the MSR transactions under the program. FHFA-OIG’s contractor noted aspects of
the BOA portfolio that were, it appears, not considered in Fannie Mae’s valuation and that could
have impacted the overall value of the portfolio.

    5. FHFA’s Oversight of the High Touch Servicing Program Was Limited
FHFA was consulted in the BOA transfer (due to the high visibility of the transaction and the
potential reputational risk); however, it had no involvement in approving the broader initiative of
which the BOA transaction was a part, nor did it approve any of the other transactions in the
High Touch Servicing Program.


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CONCLUSION
The High Touch Servicing Program itself is a fundamentally promising initiative with the
potential to reduce Fannie Mae’s – and, by extension, the taxpayers’ – losses on mortgage
guarantees, and may also serve to reduce the number of foreclosures. However, because the
program was new, large, and complex, it should have been carefully monitored by FHFA from
its inception. FHFA-OIG believes that implementing the recommendations set forth below could
help reduce the cost of transferring additional loans under the High Touch Servicing Program
from the current average of 2.3 times the annualized servicing fee to an amount closer to 2 times
the annualized servicing fee, as specified in the existing contract.




RECOMMENDATIONS
FHFA-OIG recommends that FHFA take the following actions:

    1. Delegated Authorities. FHFA should consider revising FHFA’s Delegation of
       Authorities to require FHFA approval of unusual, high-cost, new initiatives, like the High
       Touch Servicing Program.

    2. Performance Contracting. FHFA should ensure that Fannie Mae does not have to pay a
       premium to transfer inadequately performing portfolios.

         This is consistent with the Agency’s finding in the MRA. For example, this might be
         achieved through: the reduction or elimination of the 90 day period during which
         servicers are able to seek other potential buyers for a portfolio; contract provisions that
         would allow the Enterprise to purchase the servicing rights at a pre-established rate based
         on contractually established portfolio performance criteria; or some combination of these
         or other criteria. In addition, Fannie Mae could retain the right to approve the sale of
         MSR to any other servicer in order to ensure MSR can only be transferred to high
         performing servicers.

    3. Valuation. Consistent with the control issues found in Fannie Mae’s internal audit report
       on the High Touch Servicing Program, FHFA should ensure that Fannie Mae applies
       additional scrutiny and rigor to pricing significant MSR transactions.

         FHFA should consider requiring Fannie Mae to assess the valuation methods of multiple
         MSR valuators in order to discern best practices. In the case of larger MSR transactions


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         (at a threshold to be determined by FHFA), FHFA should consider requiring two
         independent valuations.

    4. Program Assessment. FHFA should assess the efficacy of the program and direct any
       necessary modifications.

         As the portfolios purchased under the program approach the five-year mark, FHFA
         should review both the underlying assumptions and the performance criteria for the High
         Touch Servicing Program.

FHFA-OIG is pleased that FHFA has accepted all the recommendations in this report. FHFA’s
formal response is set forth in Appendix A.




        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            29
OBJECTIVE, SCOPE, AND METHODOLOGY
The objective of this evaluation was to assess FHFA’s oversight of Fannie Mae’s High Touch
Servicing Program, particularly insofar as it concerned Fannie Mae’s purchase from BOA, for
nearly $500 million, of MSR on a portfolio of approximately 384,000 loans.

To address this objective, FHFA-OIG reviewed extensive documents prepared by or on behalf of
Fannie Mae pertaining to the High Touch Servicing Program, as well as to individual
transactions within the program. Among these was the valuation prepared for the BOA MSR by
Fannie Mae’s independent valuator.

FHFA-OIG reviewed documentation and correspondence created in connection with
examinations of Fannie Mae by FHFA, including correspondence pertaining to the High Touch
Servicing Program in general and BOA transaction in particular. FHFA-OIG also reviewed an
internal audit of the High Touch Servicing Program conducted by Fannie Mae.

In support of this evaluation, FHFA-OIG’s Chief Economist prepared an independent analysis of
the BOA MSR valuation.

In addition, FHFA-OIG retained an independent contractor, Beyondbond, Inc., to assist with the
assessment process; in particular, the contractor helped FHFA-OIG gather market intelligence
surrounding similar MSR transactions during the relevant time period and also evaluated
assumptions and techniques used by the independent valuator in the valuation models.

This evaluation was conducted under the authority of the Inspector General Act and is in
accordance with the Quality Standards for Inspection and Evaluation (January 2012), which was
promulgated by the Council of the Inspectors General on Integrity and Efficiency. These
standards require FHFA-OIG to plan and perform an evaluation that obtains evidence sufficient
to provide reasonable bases to support the findings and recommendations made herein. FHFA-
OIG trusts that the findings and recommendations discussed in this report meet these standards.




        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
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APPENDIX A
FHFA Management Comments




        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            31
        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            32
        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            33
        Federal Housing Finance Agency Office of Inspector General • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
                                                            34
ADDITIONAL INFORMATION AND COPIES


For additional copies of this report:

         Call the Office of Inspector General (FHFA-OIG) at: 202-730-0880

         Fax your request to: 202-318-0239

         Visit the FHFA-OIG website at: 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 our Hotline at: 1-800-793-7724

         Fax your written complaint directly to: 202-318-0358

         E-mail us at: oighotline@fhfaoig.gov

         Write to us at: 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 • EVL-2012-008 • September 18, 2012
This report contains nonpublic information and should not be disseminated outside FHFA without FHFA-OIG’s written approval.
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